The MFI Development and Regulation Bill-Part 1: What the Parliamentary Standing Committee on Finance should note?

Given the lack of a clear national microfinance policy guiding its overall strategy and implementation, the MFI Development & Regulation Bill is indeed a hugely incomplete legislation. Let’s hope that the Parliamentary Committee takes note of these aspects and ensures that these are properly redressed, before the MFIDR Bill is passed

The Micro-finance Institution Development and Regulation Bill (MFIDRB), 2012 was introduced in the Parliament 2012 and is currently being examined by the Parliamentary Standing Committee on Finance (PSCF). In a series of articles, we look at the MFIDRB (2012) and try to briefly answer the following questions…

  1. Will the MFIDRB (2012) achieve its purposes, in its current form?
  2. Does the RBI, which is proposed as the regulator and supervisor in the MFIDRB (2012) have the capacity to regulate and supervise microfinance in India?

In this first article, we look at the substantive aspects related to the MFIDRB (2012). There are five major reasons for (having) a bill like the MFIDRB (2012), which is currently under the consideration of the Parliamentary Standing Committee on Finance:

  1. To provide legitimacy and a proper regulatory framework to MFIs and others involved in delivery of financial services to low-income people (Legitimacy for Microfinance Institutions and Players);
  2. To ensure that MFIs indeed satisfy the broader objectives for which they have come into being (in the first place) and also that they operate and function in a sound and legal manner, in accordance with norms and standards required of such (pro-poor financial) institutions. This would also involve ensuring that MFIs (and especially the NBFC MFIs) don’t operate like moneylenders (Regulation and Supervision of Microfinance Institutions and Players);
  3. To protect clients from MFI bad practices like coercive repayment, abusive interest rates, fraudulent products and the like (Protection of Microfinance Clients);
  4. To protect MFIs that operate legally and correctly from usury laws (Protection of Micro-Finance Institutions);
  5. To prevent micro-finance crisis situations like what happened in AP (Andhra Pradesh) in 2010 (Prevention of Micro-Finance Crisis Situations).

What will the MFIDRB (2012) be able to achieve in its current form? In my opinion,  

  1. The MFIDRB (2012) certainly will address the aspect of providing legitimacy to MFIs
  2. It will also protect MFIs from State Usury Laws!
  3. However, it will not be able to ensure that MFIs operate in sound and legal manner. It will also not be able to stop them from operating like for profit money lenders
  4. It will also not be able to protect the MFI clients from abusive practices
  5. In short, it will not be able to prevent crisis situations like the 2010 AP crisis - where banks and MFIs lost significant (public) money including deposits (priority sector loans typically come from public deposits), the credit culture was destroyed and clients (who had once been financially included) were excluded from the larger financial system as no one would lend to defaulters marked as such in the credit bureau

That said, should the MFIDRB (2012) protect all MFIs from “State-level” usury laws? Clearly, as all of you would agree, only those MFIs that operate within the ambit of the law must be (so) protected. MFIs that engage in multiple, successive, and/or ghost lending and/or use coercive recovery practices must (surely) not be legitimized. Likewise, those institutions that have improper governance and fraudulent systems must not be protected.


What is worrying here is that the MFIDRB (2012) does not appear to have the ability to distinguish MFIs that operate legally from those MFIs that:

a) Engage in multiple, over and ghost lending;

b) Have bad governance;

c) Use coercive recovery methods;

d) Adopt abusive practices;

e) Engage in frauds;

f) Use the decentralized agent model which has many weaknesses;

g) Lack proper systems including MIS, internal control, internal audits etc;

h) Engage in connected lending;

i) Have inappropriate compensation for the bosses; and so on.


Further, the aspects of regulation and supervision of MFIs (in terms of the real and specific provisions) are not known, as much of it is to be outlined at a later date. This is a very dangerous aspect and a bill like MFIDRB (2012) cannot be loosely structured (as is presently the case).


Also, the mechanisms for client protection and grievance redressal (including self-regulation) are not adequate. Self regulation has never worked in micro-finance as the past experiences have REPEATEDLY shown—be it Krishna 2006 AP crisis, Kolar 2009 Crisis, 2010 AP crisis and thereafter. In fact, Self Regulatory Organisations (SROs) - like Sa-Dhan and MFIN—lack accountability and their track record shows that they are very ineffective bodies, many of whose members were themselves involved in such abusive MFI practices. And given that many of these member MFIs who committed frauds (like Sahayata Micro-Finance’s former MD, Ajay Verma) themselves sat on the boards of MFIN and/or Sa-Dhan, how can one expect the SROs or associations to act against other errant member MFIs (or the black sheep). As the experience of many countries has shown, self regulation in micro-finance cannot and will not work. This needs strong emphasis.


Also, permitting collection of thrift by the MFIs would be a recipe for disaster. Rather than that, if MFIs want to offer savings, they would need to enhance their systems and governance and then apply to the Reserve Bank of India (RBI) to become full-fledged banks. Given the burgeoning frauds and also the increasing use of the decentralized agent model (that caused the AP crisis in the first place), under no circumstances should collection of thrift be permitted. If MFIs are allowed to offer savings, I am sure that frauds and failures will become even more frequent and the hard earned money of the poor would be lost. Therefore, savings or thrift should not be permitted by the MFIDRB (2012) as MFIs do not have the internal control and/or internal audit systems required to safely manage peoples’ savings. And, the lessons from the 2010 AP crisis clearly articulate that.


So, in the light of the above and also given the lack of a clear national microfinance policy guiding its overall strategy and implementation, the MFIDRB (2012) is indeed a hugely incomplete legislation. I hope that the PSCF takes note of these aspects and ensures that these are properly redressed, before the Bill (MFIDRB) is passed. Otherwise, the MFIDRB (2012) will be like a recipe for a disaster (waiting to happen)!


Thus, overall, the Micro-Finance Institution Development and Regulation Bill (MFIDRB), 2012 has several problems (as noted above) which the Parliamentary Standing Committee  must note. And to be effective, the MFIDRB (2012) will need to have the following:

  1. The MFIDRB (2012) will have to specify minimum (non-negotiable) standards for various systems at MFIs – ranging from governance, compensation, risk management, MIS, internal control, internal audits, etc and the like. All MFIs which desire to come under the bill will have to follow these standards and there must be appropriate mechanisms to ensure that these standards are being met on a regular basis. The MFIDRB (2012) needs to specify these standards upfront and right now as otherwise it will not happen.
  2. The MFIDRB (2012) will also need to outline appropriate incentive and disincentive mechanisms so that the carrot and stick policy can be used to incentivise the MFIs towards client sensitive and sound operating procedures

And having seen the 2010 AP and other crisis situations in microfinance in India from very close quarters, I strongly believe that the following regulatory/supervisory arrangement would perhaps be most appropriate in the Indian context:

  1. Prudential regulation/supervision for all types of MFIs should be under a specially created body (called Micro-Finance Regulatory and Development Authority, MFRDA – like IRDA, PFRDA etc), 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, internal audits, MIS, and the like – as proposed above in MFIDRB (2012)

The MFDC (Micro-Finance Development Council) currently proposed in the MFIDRB (2012) will have huge conflicts of interest (because lenders and DFIs are to be on its board as also the MFIs).  The MFDC will also be ineffective because it would have lot of authority without any responsibility or accountability and also because there would be a dual power structure – the MFDC and the RBI, which is to be the regulator and supervisor as per the MFIDRB (2012).

  1. Capital market regulation/supervision of listed microfinance institutions (NBFC MFIs) should be under the oversight of the Securities and Exchange Board of India (SEBI).
  1. Consumer protection and grievance redressal mechanisms are necessary to ensure that NBFC MFIs don’t act as for profit money lenders. This must be led by the Micro-Finance Regulatory and Development Authority (MFRDA) - as proposed above -  along with the respective state governments, which are locally present and have the wherewithal to supervise microfinance on the operations ground. Such involvement cannot be at the level of the district administration as cursorily proposed in the MFIDRB (2012). Rather it must be at the level of the state government and using a proper mechanism. What the MFIDRB (2012) currently proposes, will NOT work on the ground!
  1. Only such a multipronged approach to regulation/supervision of MFIs would be most effective from an implementation perspective. 

In conclusion, THE MFIDRB (2012) is very loosely structured and hence, it lacks the ability to prevent events like the 2010 AP crisis, for which it was originally proposed. And the 2010 AP crisis was caused by irresponsible growth of NBFC MFIs in their search for unduly high profits, sale of their shares at a premium, personal enrichment and the like and the MFIDRB (2012) has nothing in it to prevent the recurrence of a 2010 AP like crisis situation


To summarise, India is a great country for enacting many legislations but the implementation record of the same is rather poor in most cases. I hope that the same does not happen with the MFIDRB (2012). We certainly need the MFIDRB (2012) to provide legitimacy to the microfinance sector. However, we cannot stop with that. Rather than being a paper tiger, the MFIDRB (2012) should have the teeth and mechanisms to ensure orderly growth of the microfinance sector and prevent situations like the 2010 AP crisis. I do sincerely hope that the Hon Parliamentary Standing Committee on Finance (PSCF) pays sufficient attention to these critical issues. One further point—I have flagged critical issues and the objective here is not to undermine the capacity of the RBI or the good work being planned. The objective, solely, is to assist in the development of enabling and effective regulatory and supervisory mechanisms that can work on the ground toward the benefit of large numbers of low-income people, who continue to lack access to quality financial services at the grassroots.


(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.)

Ragini Goyal
8 years ago
Sometime it seems that these self proclaimed Grassroots experts are doing more harm to the poor by restricting institutional finance rather than really helping them by improving institution based delivery of financial services to the poor.
For god sake.. this is a law.. guidelines are expected under a law and then rules under those guidelines... Unfortunately, microfinance has many self proclaimed experts and less field functionaries. It is because of these kind of enthusiasts that today again the moneylenders are ruling the roost while MFIs have shrunk.
My humble request to ivory tower based grass root experts - please let the poor get market linked services - ur overzealousness is doing more harm than good.
Ramesh S Arunachalam
Replied to Ragini Goyal comment 8 years ago
Thanks for your comments but I have never claimed to be an expert. My experience across 540 districts of India over the last 25 years suggests that we need a policy first and laws will have to follow policy and thereafter. Unless minimum standards exist and proper incentives and disincentives exist and proper implementation mechanisms are available, the MF bill be useless. Loosely structured laws and their implementation has been the bane of Indian regulation. The RBI could not supervise 5 NBFC MFIs that caused havoc in AP, which through multiple, ghost and over lending added over 2 Billion US $ in 2 years and 10 Million clients roughly in 24 months. SROs like MFIN could not check their members because their board members (Ajay Verma for one when he was on the board) were involved in serious frauds> look at MFIN's own accountability that has been written about in a previous money life article

Please wait for my 2nd book to see a complete list of frauds perpetuated in the name of market led micro-finance - I give all the proof with all the names and e mails. Please look at money life articles on agents which again provides proof as also the corporate governance pieces. In the name of market services, the frauds that were perpetuated is very clearly written in my 1st book and please take a look at that. Send me your address to [email protected] and I will mail you a copy of the book which has more proof than required. I am thorough with my research and evidence and I will stand up for what I say!

Finally, I strongly object to your personal DEFAMATORY comments - self proclaimed grass-roots expert and ivory tower based grass root experts. I never claimed to be AN EXPERT and the kind of personal comments you make are not fair. If you have a problem with the views I express counter them with arguments and evidence and solid evidence. I check and double check my evidence and do you know that despite naming several organisations and people in my first book and articles, I have not been challenged even once and even if they do, I am prepared because I have all the proof. In fact, I have been very nice to MFIs by not naming all the scandalous organisations or individuals but people like you are perhaps pushing me to it. Specifically, I can prove the frauds done by many MFIs in the name of market services and I have already published a lot of that in money life and my 1st book. My 2nd book completes the cycle. I dont make statements without proof not make personal remarks. Thanks

Lastly, I do appreciate your views that lack of MFI services in AP has led to people suffering but that does not mean we can have badly structured laws - there are huge conflicts of interest in the MFI bill. Read my forthcoming articles and you will understand.

Let me set the record straight - I want a thriving MFI profitable sector but one that is responsible, well-governed, has good systems, but most importantly, one that is fair to its various stakeholders including clients and shareholders. And good appropriately structured regulation plays an important part in this and I am afraid the present MF bill is hardly appropriate from that perspective.

See what happened in micro-finance in the Governance of compensation by so called market led MFIs. Also, When MFIs make money by ghost lending and multiple lending and investing in real estate and building schools/colleges, I cannot call it as priority sector lending micro-finance. PSL micro-finance is lending to the poor.

Thanks anyway for your comments anyway
Free Helpline
Legal Credit