A number of short-term issues need to be tackled expeditiously for resolving the Indian microfinance crisis

The time to act decisively has come now. The RBI, Ministry of Finance, the Andhra Pradesh government, MFIs and other stakeholders must get into mission mode and set a number of checks and balances in place to overcome the huge unfolding crisis which is likely to completely distort or destroy the low income rural economy

The deadline for providing feedback to the draft Microfinance Bill put up on the website of the Union Ministry of Finance was over on 7th August. It is 'feedback analysis' time now with regard to the Bill. How long the Bill may take to become an Act is unclear, but the ground situation is indeed deteriorating and more importantly, the low income economy is slowly but surely getting devastated due to money-lending by field staff/agents and several other factors including lack of institutional funds for the low-income segment.

Therefore, while it may be appropriate to continue debating about microfinance regulation and its potential to solve the present crisis, let me also warn you that there can be no lasting solution to the present problems in Indian microfinance unless the following short-term issues are tackled expeditiously. And irrespective of whether and when the RBI (Reserve Bank of India) or a new regulatory authority takes charge of Indian microfinance, there is indeed a pressing need to deal with aspects such as those identified below.

First, in real terms, many of the MFIs (microfinance institutions) in India have large holes in their balance sheet and especially, the ones headquartered out of Andhra Pradesh. While an NBFC (non-banking finance company) MFI like BASIX may be able to get a lifeline, the others are unlikely to get such help. And given that the contagion is slowly but surely spreading to some of the neighbouring states, it is only a matter of time before which these other MFIs will also have huge gaping holes in their balance sheets. Therefore, without resolving the crisis in Andhra Pradesh and other parts of India where it is gaining momentum, let us be clear that no bank will seriously lend to MFIs (in the future) irrespective of any direction from any authority whosoever. And without such bank funding, MFIs cannot really survive, let alone expand. This is a very realistic assessment in my opinion.

Second, please also recall that three large NBFC MFIs headquartered in Andhra Pradesh had opted for debt restructuring while the cash rich SKSMLi  is said to be going in for private (institutional) placement of its equity. While some of us may think that the debt restructuring and/or access to (some) equity funds would help resolve the crisis, at best, these are strategies for merely postponing the occurrence of the large gaping hole in the balance sheet of various MFIs. And this is something that all the banks are aware of and so, large-scale financing of MFIs is unlikely because of this aspect as also due to the solid image beating that microfinance has received in the last 12 months. In fact, one banker whom I spoke to summed it up aptly: "How can we lend to these MFIs knowing very well that their balance sheets are due to take a huge hit, somewhere soon and also given the fact that many MFIs really need to get their house in order in terms of various systems, agents, multiple lending, shared clients and the like?"

I found the above remark interesting as it helped me become clear on the fact that overcoming the present microfinance crisis requires much more concrete action on the ground rather than mere talk of provision of some loan funds or equity to MFIs. Without doubt, it calls for fundamental changes in the way microfinance is practiced and as Dr C Rangarajan, Chairman, Prime Minister's Economic Advisory Council, said last year, the business model of NBFCs needs to undergo a radical change. And unless that happens, state governments cannot be carried along and as long as they are not part of the solution, Indian microfinance cannot and will not take off again. Make no mistake about that. Therefore, it is in everyone's interest to introspect with integrity and come up with an optimal solution to this crisis and I believe that this is indeed possible. And accordingly, I offer some initial (suggested) proposals towards:

1.    Identifying shared clients/JLGs with multiple loans:
A quick and fair identification of all clients with multiple parallel loansii  and high levels of indebtedness and their associated JLGs (Joint Liability Groups)/SHGs (Self-help Groups) across all districts in Andhra Pradesh and other states needs to be done immediately. The RBI must lead in this effort and ensure a high level of openness among all the stakeholders participating in this exercise. Further, disbursement of standard (consumption) microfinance loans to such clients (from various sources) must be stopped immediately and they must be provided other appropriate interventions as identified in point 2 below.

2.    Deal practically with clients having multiple loans: Practical approaches need to be evolved for dealing with clients who have several loans and are facing a high level of indebtedness. Among other things, this calls for objective and candid engagement among various stakeholders including client representatives, MFIs, banks, investors, the Ministry of Finance, state governments, regulators and others concerned. If this is not done, the crisis will surely erupt again as many low income people with debts greater than Rs1,00,000 are in no real position to pay back their loans from their own (known) sources of cash/income. They are the classic subprime cases like clients from whom money was (is) being recovered, if at all, through regular greening (top-up loans) and other coercive collection strategies.

Given that both of the above should not be encouraged, we need to evolve practical approaches for mitigating the indebtedness of such clients through strategies such as the following: (a) debt swap which could also involve banks/MFIs completely taking over a clients' loan dues and/or banks taking over an MFI (acquisition); (b) moratorium on interest/principal for a specific period of time; (c) rescheduling/restructuring of loans with a longer repayment period and changes to other loan terms; (d) partial or complete waiver of loans in cases of the ultra poor (those with extremely poor livelihoods and high levels of poverty/vulnerability and no serious means to repay their huge loans); (e) access to livelihood loans, especially post production or post harvest; (f) access to risk mitigating and vulnerability reducing financial services and so on. However, these are not exhaustive suggestions but rather indicative ideas which need to be explored further, consensually developed and practically implemented on the ground.{break}
3.    Ensure regular microfinance for clients not having multiple loans: The regulators/RBI must take the lead and work—together with the Andhra Pradesh and other State Governments, Sa-Dhan, MFIN (Microfinance Institutions Network), INAFI (International Network of Alternative Financial Institutions) and other stakeholders—to ensure that regular microfinance businessiii  takes off in Andhra Pradesh and other states. Among other things, this would imply greater access to livelihood loans and risk mitigating/vulnerability reducing financial services and there should be no compromise on that. This also requires that the various stakeholders make solid and credible commitments to set up and implement proper loan origination/recovery mechanisms and related systems to: (a) prevent multiple, over and ghost lending; and (b) protect clients and public money including priority sector funds; and (c) also ensure speedy redressal of any consumer complaints on the ground. And without any doubt, client protection and redressal mechanisms must incorporate a clear constructive role for state governments and the microfinance industry just cannot escape that fact anymore.

4.    Create a uniform practical code of conduct for MFIs and ensure compliance on the ground: There must a credible assurance from MFIN, Sa-Dhan, INAFI and other networks that MFIs will ensure that they do not lend (indiscriminately) to those clients who have not (so far) been affected by huge levels of indebtedness. In this regard, I think the RBI's fair practices code could be used as a basis for developing and implementing a code of conduct for microfinance, obviously incorporating critical points from Sa-Dhan's and MFIN's code of conduct. In the code, MFIs must commit that they would actively encourage and support clients with JLG type loans for amounts below Rs25,000 for first-time loans and Rs50,000 for 2nd or 3rd cycle loans (for a variety of purposes). They must also commit that all loan amounts above the Rs50,000 category would have to be dealt with under the individual lending paradigm by the MFIs and such loans would mainly be for productive and livelihood purposes and appraised accordingly based on cash-flows.

Measurement of whether the code of conduct is operational or not (at the ground level) is also going to be very critical and it must be carried out by an independent agency without any conflict of interest. Getting technical support and/or rating agencies that are already involved in the microfinance industry to do this will surely help produce great sounding 'code of conduct' reports with high compliance whereas, in reality, many aspects may not be implemented. Let us not forget what happened during the last three to four years, when we thought all was well (based on such reports by several stakeholders) but the events of 2010 turned out otherwise.  

5.    Integrate credit bureau with CIBIL and ensure credit bureau has regulatory support:

a.    The idea of MFIN or any other industry association facilitating implementation of the credit bureau is welcome but it is also fraught with danger as there are huge conflicts of interest, which I have been raising all through in my writings. Therefore, it seems most appropriate to integrate the proposed microfinance client credit bureau with CIBIL's (Credit Information Bureau India Ltd) operations and the regulator must take a lead in doing thisiv . In other words, there must be regulatory ownership of the proposed credit bureau—otherwise, it simply will not take off. Please recall that when MFIN started out, somewhere in late 2009, they talked of a credit bureau being established by mid-2010 but it has not happened till even half-way through 2011. There are no serious signs of a microfinance credit bureau coming into being— by this, I mean the transparent public use of a credit bureau by financial sector entities as opposed to mere statements being made for the public consumption. These are mere apologies—but we cannot take such statements at face value anymore as much of what the microfinance industry has stated in the last few years, has turned out be very different.

b.    Further, while credit bureaus are very useful, the regulatory/supervisory authority must own the credit bureau and the central database should be available for use (on a lease basis) for the different credit bureau service providers. MFIs can link up to different credit bureaus service providers to submit the data but all of this information will have to go into the regulator/supervisor established single central database. Likewise, all concerned industry stakeholders should be able to access this data at a cost of course, subject to various terms and conditions. And it would be best if the credit bureau architecture piggybacks on unique national IDs for each individual, accessing a microfinance loan. Only then, can the microfinance assets become really traceable and accounted for in the complete sense and the real impact of financial inclusion and priority sector lending efforts be transparently and objectively supervised and determined.

6.    Legitimise the lenders forum through a regulatory mandate: Leverage the lenders forum that has been set up under the World Bank SIDBI Responsible Microfinance Project to ensure all of the above and also lay the foundations for a better system of monitoring and supervision of microfinance assets as suggested below:

a.    Ensure a consortium approach for lending to large MFIs: The lenders will have to take a consortium approach to lending to the MFIs {at least for those MFIs that have portfolios greater than Rs100 crore and are considered systemically important as per RBI/Union Ministry of Finance guidelines}. This will prevent MFIs from setting off one lender against another and also ensure that the microfinance market is less of a borrower-dominated market. If one were to look at the instances in the years 2008-2010, there are a number of cases from India where MFIs set off one lender against another and this led to dilution of terms and conditions, including monitoring and supervisory arrangements. In my opinion, a lot of the present problems in India can be attributed to such tactics. Again, "consortium lending" is something that only the regulator can mandate via regulation and ensure through supervision. And make no mistake, no lenders forum (even those established through the ongoing World Bank responsible microfinance project) can ensure consortium lending because, by their very nature, the lenders are fierce competitors for the available large- and medium-sized MFIs. Therefore, only a regulatory diktat can ensure this on the ground.

b.    Consortium to choose rating agency and ensure no conflict of interest: While lenders typically use rating agencies prior to sanctioning a loan, in this case it is the consortium that must choose a credit rating agency, which among other things must be really independent in terms of not having any other relationship to the larger microfinance industry and the MFI being rated—especially, the rating agency must not have a sister concern that is involved in capacity building and/or be a part of a larger corporate group that has such interests in the microfinance industry. Also, ratings for the same MFI must be rotated among the mainstream rating agencies so that repeat ratings do not become a wrong incentive (or an incentive for providing a higher rating grade). And raw data collected as part of the ratings must be made available for verification by the supervisors', their examiners and lenders' internal auditors, as and when required. This may not even be used but it still has to be provided by the rating agency to the consortium of lenders.

c.    Ensure exclusivity of microfinance assets across lenders: To enable better monitoring, the exclusivity of microfinance assets to specific lenders must be ensured and that is something that only the regulator can mandate via regulation and ensure through supervision. As per this, each MFI will have to exclusively earmark certain number of whole branches/units across its portfolio and geographies to respective lenders. And this should not be done on a geographic basis as then it may be unfair to some lenders-rather allocation of branches should be done in a fair manner using stratified (by quality of branches) random sampling methodology to ensure that all lenders get a somewhat equal share of excellent, good and ordinary branches. This will ensure equitable distribution of portfolio at risk across the lenders and also facilitate better supervision on the ground.

d.    Make high-quality randomised loan portfolio audits mandatory on an annual basis: While many of the banks and lenders are going in for loan portfolio audits and the like , much of the principles used in all these toolkits will have to be changed significantly, especially in line with lessons from the present Indian crisis. And mainly, client level sensitivities and the prevalence of decentralised models/agents and their practices will have to be factored in specifically. Further, loan portfolio audits are seldom effective in the absence of a transparent MIS (management information system) that is integrated across geographies, products and clients groups and that again needs to be ensured on the ground. Also, loan portfolio audits must be conducted by people who are not only independent evaluators but also seen to be independent in terms of having no other relationship with the concerned MFI (or the larger microfinance industry), at least over the previous three years. And finally, there is a critical need for ensuring statistically valid random sampling of an MFI's portfolio while conducting such an audit and that again needs to be implemented on the ground. All of this can be ensured only by regulation and it is hoped that the regulators will do that and also ensure implementation through appropriate supervisory arrangements. While credit rating agencies could also conduct the loan portfolio audits, they must adhere to the transparent terms set out above for portfolio audits. Finally, the conflict of interest aspect mentioned for credit rating agencies must also be followed here in that agencies involved in doing portfolio audits or credit rating should not have any other relationship with the entity being audited/rated, at least for the preceding three years in question.

e.    Make it mandatory for MFIs to provide an annual MIS and systems audit report: Another issue that needs to be made mandatory by regulators is the requirement of an annual MIS and other systems audit-to be certified after due examination by regulator/supervisor empanelled professionals. An appropriate process should be followed for such certification to be effective. This must form part of the annual filing of returns along with the aforementioned annual loan portfolio audit certificate.

To sum up, irrespective of what caused the crisis, the time to act decisively has come now and the RBI, Ministry of Finance, the Andhra Pradesh government, MFIs and other stakeholders must therefore get into mission mode to overcome the huge unfolding crisis which is likely to completely distort and/or destroy the low income (rural) economy. And if that happens, the Indian microfinance industry will start to see a light at the far end of the long tunnel.

  iSKS Microfinance Limited
  iiI do not want to get into the debate on how many loans should be the ceiling here but certainly, it would be worth looking at clients having 4 or more simultaneous loans that are currently outstanding, who received loans in excess of Rs 100,000.
  iiiThis should encompass both disbursements and repayment collections for all clients not falling under the category of highly indebted clients as described above.
 iv The clients with multiple loans (identified in step # 1) could form the basic platform of this credit bureau. Slowly other clients (identified in step 3) could be brought into the credit bureau.
 v I myself participated in the development of loan portfolio audit toolkit that is prominently used in India and other countries but all of these need to be modified significantly in the light of the Indian microfinance crisis

(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.)

1 decade ago
MFIs are OK as long as they function as NGOs / earns minimum profits. The moment they try to create value for their share holders / promoters, they cease to exists.
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