The micro-finance bill must provide a clear pathway to preventing occurrence of the various problems so that crisis situations can be avoided in the future

It is great news that finally the draft micro-finance bill will be introduced in the winter session of Parliament. While undoubtedly, the regulatory architecture for Indian micro-finance needs urgent attention, the efforts to have some framework should not result in the adoption of a regulatory mechanism that does not serve the real problems at hand. That is something that the various stakeholders must ascertain even as they evaluate the draft micro-finance bill so that appropriate features are introduced into it.

In a series of articles, Moneylife will raise ground level and (MFI) organizational issues to ensure that the various stakeholders debating the draft bill indeed have all relevant information in the public domain with regard to the 2010 micro-finance crisis. In many ways, the essence of regulation is to prevent market and institutional failures and therefore the micro-finance bill must provide a clear pathway to preventing occurrence of the various problems so that crisis situations can be avoided in the future.

For starters, here are a list of ground level issues from Andhra Pradesh (AP) and other states and I would like various stakeholders to ask the question as to whether the proposed bill would prevent any of these problems and if so, how?

First is the issue of information. Incorrect or misleading information (e.g., of interest rates on loans) is often provided as part of the sale strategy so as to influence sale positively for the MFI/institution.

• The MFIs concerned 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. This has especially become a huge issue in the decentralized agent led model, where the last mile end user clients are not known to the MFI and the agents are free to set their own pricing. In fact, the demanding of kickbacks (bakshish), often as a percentage/flat fee has also been used as a strategy by the field staff/agents of some MFIs
•  A related issue is that other (insurance) charges are also usually not mentioned and hence the effective cost to the client is much higher.
•  Also, all terms and conditions are not clearly mentioned to the client including delayed payment penalties for loan installments and the like.
•  One another point that needs to be highlighted is that while there are several well intentioned initiatives on transparent pricing none of them have the depth of coverage in the field to unearth the above and thereby, the actual interest and other charges levied on the ground  

Second is the aspect of inappropriate targeting, sales promotion and client/loan origination techniques caused by the processes at many MFIs which have tended to be somewhat reckless - hence, loans have been made without due reference to the borrower’s ability to repay resulting in over indebtedness and multiple lending. Many times, the field staff (of some MFIs) have used inappropriate sales techniques to acquire a client - e.g., hard selling through multiple home visitation, promise to ‘green’ (or refinance) subsequent loans, door-to-door solicitations, limited-time offers and even intimidation. And many of these clients tend to be clients with other MFIs as well. As a result, the loan absorption capacity of the clients are neither known nor used in decision making. In the agent-led decentralized models, as the last mile end user client is frequently not known, the above problems become more serious. And, the fact that unique identifiers are absent for these low income clients further exacerbates this problem (you can have several women in the same village with same name and initial and have almost similar addresses). Even the most sophisticated credit bureau cannot spot these without unique identifiers. Other aspects here are imposition of unnecessary fees/surcharges, consolidation of debts at a much higher (interest) rate and provision of loans to pay insurance premiums and the like etc. - All of these result in over-indebtedness (among clients) that could cause 2010 type of micro-finance crisis to reappear, time and again.  

A third issue relates to loan contracts, which in many cases do not provide full disclosure of costs and other terms. They often have inappropriate wording regarding client obligations that they (clients) do not understand. Further, written documents do not reflect the terms and conditions agreed before transaction was made and this is a very crucial issue. This aspect is also compounded by the fact that clients (in many cases) are not given copies of contracts, policies, records or other documents

Fourth is the aspect of frauds (please refer to previous Moneylife article ), Increasing frauds, internal lapses at MFIs: Need to strengthen supervisory arrangements to protect the poor that lists various types of (increasing) frauds in Indian micro-finance. In several MFIs, ghost loans have been made to real/ghost clients. Further, fraudulent loans, where part of the loans is given to clients and part loans are taken by staff is another common problem. Much of this stems from serious lack of internal and client-level controls at the operational level (for the concerned MFIs). This is also exacerbated by the use of the decentralized agent model. Also, in many cases, inaccurate recording of client’s transactions has meant that more money is collected from clients (who neither have access to records nor are able to fully comprehend them). In several cases, clients are presented wrong balances in terms of loan outstanding and/or other aspects as well. Further, illegal/fraudulent methods of payment collection has also been observed in the field, where full payments are shown as delinquent payments and pre-payments are recorded as regular payments – in both cases, the hard earned money of client’s is lost.

Last, but not the least, is the issue of loan repayment collection. Physically abusive behavior in the payment (loan repayment) collection process has been observed on a regular basis during the 2010 AP crisis. There is enough evidence regarding the fact that illegal and abusive behavior was used to force over-indebted clients (without requisite sources of income) to repay loans in Andhra Pradesh and other (saturated) areas that had significant multiple lending. Some of these include hard intimidatory actions like staff/agents sitting in protest at the client’s house/workplace. Often, collaterals like ration card or house patta (title deeds) were physically taken even though the micro-finance contract specifies non-collateral lending.

There are many other issues including organizational aspects (governance etc.) which will be taken up in subsequent articles. Without question, aspects like the above cannot be monitored and set right by the Central Bank, Micro-Finance Associations, SROs etc. They require a local presence and can be done perhaps by the state governments alone, who on their part must become neutral to micro-finance models. Make no mistake, if problems such as the above are brushed aside, the AP type micro-finance crisis will reappear again.

And this is something that I hope that drafters of the proposed micro-finance bill and other stakeholders seriously consider while passing the proposed bill into a law. A bill that does not assure tangible protection against the above problems would be a mere paper tiger with no ground-level effectiveness. And indeed, this aspect assumes greater significance because as a country we are committed to inclusive growth for which inclusive finance is a necessary condition. And if the above problems are not addressed by the proposed Micro-finance bill to be introduced in Parliament, inclusive finance will surely become a recipe for disaster as was witnessed in 2010 in Andhra Pradesh…and then, inclusive growth will continue to remain an elusive dream…