Thursday, February 3, 2011

RBI (Malegam) Report: What's on the Platter? Guest Post

We encourage you to submit your opinions to RBI by the due date. In the meanwhile we are publishing an excellent reaction by another blog.

The Malegam Committee Report on Micro-Finance: What’s On the Platter? 
Ramesh S Arunachalam

The much-awaited Malegam committee report is laudable because it is the 1st committee report of (some) significance to attempt the creation on of a (national) regulatory framework for MF in India. The Malegam committee report must be strongly appreciated because it seeks to legitimize microfinance as an integral part of the Indian financial sector. By recommending creation of a new category - called NBFC MFIs (with associated conditions which are perhaps open for discussion) - the report has clearly positioned and mainstreamed micro-finance within the framework of the larger financial sector in India. This ensures that micro-finance will come under the purview of the RBI and no longer can microfinance be treated as a fringe activity or as an orphaned child in the larger Indian financial sector.

A second aspect that deserves appreciation is the fact that while the report has recommended continuation of priority sector funds for MFIs, it was however made it conditional - especially after recognizing some of the key problems like ghost lending, multiple lending, over lending and attempting to outline some measure to tackle them as well.

A third issue that merits appreciation is the fact that the report has sought to promote greater transparency with regard to interest rates…through various measures.

Fourth, the report has recognized and stressed the importance of off-site and on-site supervision of NBFC MFIs (including systemically important ones) while also alluding to the need for significantly enhancing the supervisory capacity of RBI with regard to micro-finance.

Fifth, the strong emphasis on corporate governance is note worthy and specifically, the committee has suggested that corporate governance rules will have to be specified (encompassing several issues) for NBFC MFIs by the regulator. A very critical aspect indeed…

Sixth, there are several other aspects in the report that require commendation:

  • The intent to ensure that the aggregate amount of loans given for income generation purposes is not less than 75% of the total loans given by the MFIs;
  • The strong desire to deal with multiple lending, over lending and ghost lending through several measures including better loan origination procedures, establishment of a credit bureau etc
  • The emphasis on having strong client projection measures in place including various codes for MFIs
  • The desire to keep NBFC MFIs out of the purview of state level money lending acts

That said, I am therefore a bit perplexed by the strong (initial) criticisms of the Malegam report…While stakeholders appear to have perceived several weaknesses in the report, I try to list some of these below and provide some explanations with regard to these issues, apart from suggesting ways forward. Many of these issues can (easily) be addressed by dialogue and discussion and do not take away the excellent work done by Malegam committee – that is a point that I would like to make clear upfront…Read on…

1. The first cited issue is that the ‘implementation mechanisms’ proposed with regard to various suggested measures perhaps lack the required depth and detailing - but that is (only) to be expected in any such first cut broad strategy report. I think it would be unfair to criticize the Malegam committee report on the lack of implementation detail - after all, much of this can be detailed out only after the RBI accepts the various recommendations and I am sure that necessary precautions (by the RBI) will be taken with regard to codes of conduct, client protection measures, corporate governance etc

2. A second aspect is the use of caps for annual family income, restricting it to Rs.50, 000/-. This is admittedly a suggestion that perhaps cannot be implemented on the ground. On the contrary, this condition could in fact serve to encourage local level corruption, as more and more clients and MFIs seek to get <Rs.50,000/- annual income certificates from the local village administrative officers (or equivalents). It would be impossible to enforce this and in the spirit of argument - “Do not regulate something that you cannot supervise” – it may even be better to remove this artificial barrier.

3. A third issue is the capping of “overall interest” and “margins” as well as loan size and total loan amount outstanding - they are again not feasible to implement on the ground and can be easily overcome as shown by the past experience with SSI loan and other such (lending) limits.

The committee must also recognize that caps on loan sizes and total loan outstanding may be somewhat restrictive for the clients and perhaps even at variation with current RBI policy. Therefore, this aspect also needs to re-looked and adapted accordingly. Further, the capping of loan amounts and loan outstanding would severely hurt the clients (in the medium and long term) in their efforts to climb out of poverty. Hence, the committee may want to go with the existing RBI ceiling of Rs 50,000 for loan size as well as total loan outstanding and back it up by ensuring that MFIs have good loan origination and appraisal systems (especially, for large non-consumption loans to individuals, which must also be permitted) and appropriate ceilings for consumption loans (as already proposed by the committee)

The capping of interest could severely hurt the prospects of nascent/small MFIs and those operating in difficult terrains. More importantly, the resultant search for greater efficiencies will surely result in more short cuts being taken with regard to client acquisition, client engagement and the like - we all know what problems that (all of) this caused in AP in the recent past. Hence, the committee may consider removal of the capping on overall interest, while continuing to suggest the capping of the margins – but through more appropriate slabs and with greater flexibility to accommodate the diverse nature of Indian micro-finance and MFIs. This would be a pareto optimal solution indeed…

An alternative would be to completely remove these caps and go in for caps on return on equity and/or dividends…as this blog writer had proposed earlier…

4. Fourth, given the need for pluralism and choice, it would be appropriate if the committee recognizes and provides legitimacy/space for operation of other legal forms of MFIs including non-profits and mutual benefit institutions. Even if the RBI does not regulate/supervise them (and in all fairness, perhaps cannot do so in a legal sense without amendments to its own acts), this legitimacy provision will go a long way in ensuring that: a) banks lend to these institutions (I have already heard that some banks are telling some MFIs that only large NBFC MFIs will be supported hereafter); and b) usury laws are not used against them, in an operational sense, as has happened in Andhra Pradesh.

5. Fifth, even within the category of NBFC MFIs, the Rs 15 crore net worth requirement seems a big ask for the small and nascent MFIs. Therefore, it would be appropriate if the committee reconsiders this aspect so that all existing small and nascent players – both NBFCs and those NGO MFIs ready and desiring to transform - are not unduly inconvenienced. This seems fair from an equity (pun intended) perspective…
6. Sixth, Sa-dhan has played a very important role in the development of the Indian microfinance industry and the requirement of an association having 33 1/3 % of its members as NBFC MFIs needs to re-looked at from a practical stand point. At any rate, not treating Sa-dhan as an MFI association will again be perceived as patently unfair and hence, this aspect also needs to be reconsidered…and perhaps changed accordingly...

7. Seventh, it would be important for the committee/RBI to take cognizance of the (widely prevalent) agent model of micro-finance in India and address issues related to the use of agents – much of the multiple, ghost, over lending and recovery practices can be traced to the use of this fast tracked model that puts clients as the very last… Read on…  

8. Eighth, it would also be useful if the committee looks at the aspect of equity investment in MFIs and build necessary safeguards to ensure that what happened in AP does not recur again. Specifically, the aspect of MFIs growing very, very fast (through multiple, ghost and over lending), perhaps, on their volition and at the behest of (private) equity investors so as to provide greater and faster returns for themselves/investors/shareholders and get further investments at a premium and so on… needs to be looked at closely by the committee/RBI and strongly addressed…Otherwise, we may have a few Satyam like situations down the road…

9. Last but not the least, the report pf the committee, while providing a good framework for the future, perhaps does not adequately address the existing crisis situation (in AP and slowly beginning to unfold in Tamil Nadu) and issues around these – there are a large number of clients and JLG who have been shared at the field level, with each MFI reaching out to them, on a specific day of the week. For example, there are sometimes 6 MFIs sharing a JLG and its clients and this has been the REAL secret of the micro-finance growth story so far…Add to this the huge levels of indebtedness on the ground and I am not sure that the report provides any way out for these aspects…I hope that the committee and RBI look into and address these issues as otherwise, there would be no REAL way forward…

Overall, the Malegam Committee has done a highly commendable job with a very complex problem and that needs to fully recognized and well appreciated. It has shown the right strategic intent and direction for establishing a uniform national regulatory framework for micro-finance in India that attempts to put clients first…Ladies and Gentlemen, let us give the committee a Big Warm Hand…rather than JUST nitpicking on specific issues that can (perhaps) be sorted out through discussion and dialogue…Clearly, it is about time that we - stop being Penny Wise and Pound Foolish and - recognize the huge and legitimate platform for action that the Malegam committee has provided all of us

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