Tuesday, January 25, 2011

Malegam Report leaves more questions than answers

Malegam Committee on Micro Finance
Leaves more questions than answers.
B. Yerram Raju*

MFIs were balancing between equity and discipline – the area that the other lending arms in the country, both the commercial and cooperative banks failed to perform. Nurturing them, therefore, is essential for achieving the goal of financial inclusion. It is good to recall what M. Narasimham, the architect of Financial Sector Reforms in India told when the Reforms ushered in: the Banks and Financing Institutions should be freed from the regulatory bondage in interest rate fixation and prescriptive approaches to specific clientele groups-behest or directed lending. During the last two decades while many positive efforts in the Reform Agenda saved the country from the Asian and global crises situations under the able stewardship of illustrious Governors, there were also gaps that needed a pragmatic attention. One such gap is Micro Finance regulation. Does Malegam Committee provide any solutions? Or leaves many unanswered questions? This is what this article intends to examine.


Following RBI circular dated 18th February 2000 providing guidelines to financing of MFIs by commercial banks, there has been rapid increase of private MFIs in the country during this decade. Most of these MFIs are broadly in four categories.

1) NGO MFIs – Registered under Societies Registration Act 1860 and/or Indian Trust Act, 1880
2) COOPERATIVE MFIs – Registered under State Cooperatives Act or Mutually Aided Cooperatives Act (MACS) or Multi-State Cooperatives Act, 2002.
3) NON-BANKING FINANCIAL COMPANIES(NBFC) MFIs- Registered under Section 25 of Companies Act, 1956 (Not for Profit)
4) NBFC –MFIs – Registered under Companies Act, 1956 and Registered with SEBI where they went in for public issue and/or with RBI.

In order to encourage the MFI movement, the RBI desired that they go under self-regulation mode and the RBI expressed categorical “NO” to MFI regulation. On the top of it, the Central Bank categorized all corporate loans granted to MFIs as part of priority sector lending and the public sector banks found a bonanza in such categorization as they can claim credit under somebody else’s shoulder without having to incur the huge cost of reaching the poor and realizing such loans again at a huge cost. Suddenly they found a de-risking their otherwise high-risk portfolio. Bulk loaning to MFIs moved at 8-12 percent for online lending to the poverty groups.

The bulk lending in the MFI robes, on the other hand, has taken the ugly turn witnessed during September-November 2010 prompting the former Governor RBI, Dr. Y.V. Reddy calling it India Sub-prime story, due to the following reasons:
1. The incentive of booking such credit under the priority sector
2. Banks that usually stipulate stringent conditions on the high-risk ‘poor’ refused to see a part of it even when lending to MFI because of their myopic approach to priority sector credit.
3. The Commercial banks were quick to respond to the glossy balance sheets; foreign flows and the bee-lining of venture capital funds because of the minimum of 8-12 percent yield on these assets and near 100 percent repayments.
4. The investors walked away with the high returns, which is nothing but the rich walking on poor man’s incomes. Poor man’s rupees walked into rich man’s dollars. This is not certainly what either the Government or the RBI intended when they spoke of financial inclusion.
5. Micro Insurance is not linked.
Corporate greed overtook the poor man’s need. Banks too were no less greedy as they could fulfill their priority sector targets without actually having to go near the poor.

Even most of the private sector banks that were unable to fulfill their Priority Sector obligations due to their lack of presence in Semi-Urban and Rural Centers or lack of initiative in financing SME or other Priority segments, have found an easier option of providing bulk loans to MFIs. This paved the way for large-scale flow of depositors’ funds to MFIs for their onlending activities. There are 44 RBI recognized MFIs in the country according to Microfinance Institutions Network. Some well meaningful entities have put the training of the poor in viable economic homestead and village level activities ( BASIX for example) and created enthusiasm and confidence in institutional lenders for this activity. But greed has no boundaries and seeing large-scale benefits with a little effort and much propaganda, others bee-lined and Banks qued up to lending to the opportunistic and showy MFIs. This led to mushrooming of MFIs accessing huge funds from Commercial Banks for their onlending activities. Most commercial banks lent them for 12 months with the result the MFIs had to recover in weekly repayments. According to Malegam Committee: “As at 31st March 2010, the aggregate amount outstanding in respect of loans granted by banks and SIDBI to NBFCs operating in the Microfinance sector amounted to Rs.13,800 crores. In addition, banks were holding securitized paper issued by NBFCs for an amount of Rs.4200 crores. Banks and Financial Institutions including SIDBI also had made investments in the equity of such NBFCs.”

The issues relating to MFIs did not come to surface suddenly. The State Level Bankers’ Committee Reports during the past few years have been indicating NPAs growing the SHG –Bank Linkage programme and MFIs charging usurious rates in 2006. The State Government had a knee-jerk reaction in promulgating “Andhra Pradesh Microfinance Institutions (Regulation of Money Lending) Ordinance, 2010 on 15th October 2010 that subsequently became an Act.

SBL programme implemented by NABARD since 1994 with the involvement of public sector banks, cooperative and rural banks creditably has no record of suicides or even extortion in recovery process. Capacity building of groups and building group dynamics saw several innovations that resulted in some of the groups taking up agricultural marketing activity in the villages. (For example, in Nizamabad District the SHGs collected maize crop of 3lakh tons and sold at remunerative prices for the farmers and good margins for themselves. There are also built-in insurance mechanisms as well. Andhra Pradesh leads this movement.
There are private players like the Cooperative Development Foundation (CDF)and Centre for Collective Development (CCD) that built SHGs around the concept of small savings of the Women groups initially. The group saves in small sums and the individual members’ needs are met out of the savings: the savings receive interest at the rate decided by the group ( this is around 12%p.a) and the credit for any purpose that the members approve would be charged at 15% and they also build ‘Abhaya Nidhi’ an insurance fund for any untoward calamity to any member. CDF has built a women’s dairy while the CCD has built even Oil Mill with the financial support of NCDC. Most of these groups have a livelihood support programme behind them.


While the AP Government sounded the alarm with the ordinance that was really not necessary as the existing laws would take adequate care of punishing the usurious lenders on one hand and violent extortionists on the other, the MFIs have been disrobed. The question that still haunts is whether the registration of MFIs would help the cause of the poor. I doubt.

Why Suicides in AP alone?

Whether it is farmers or micro credit borrowers, failure in repayment of loans is the root cause of suicides and these have been occurring mostly in Andhra Pradesh in spite of several measures taken by both the Central Government (separate package of loan waiver announced; interest subvention announced in the farm sector in 2007-08). This is because of the enlarged inadequacies of credit-related infrastructure for institutional lenders to move aggressively on one hand and social divide on the other. All the schemes announced by the Government have built-in rent seeking opportunities for the bureaucracy and politicians with only a portion of the schemes reaching the poor. Secondly, in the villages, there is a clear rich-poor divide on caste considerations. The sufferings on any account whatsoever are mostly unattended. The neighbours expect only the Government to take care of them. Andhra Pradesh is one of those few States declaring reduction of poverty to a mere 16% in the backdrop of state economy growing at a steady 6% and above at the beginning of this century. At the same time there is uneven distribution, rampant corruption and heavy politicization of any and all schemes that are meant to reach the poor.

MFI could make a difference in this scenario as there were no strings attached to the loans and the loans were being available in bigger slices than the SBLs at their door step. Little did they realize that the no-strings loans had ropes around their necks running like a computer programme.

Lending money has to be distinguished from extending credit.

Under what parameters, the Banks were doing bulk lending amounting to hundreds of crores to unregulated MFIs? Whether they were lending against any collateral security offered by MFIs or whether their lending to MFIs has any relation to relative net worth of MFIs? What are the precautions taken by Banks to ensure against misuse of funds by MFIs or protect the public money in case of default by MFIs? When the Banks knew pretty well that this is for re-lending, why did not impose conditions on its use and cost of operation? Every lender imposes such covenants in their loan agreements. To blame it on MFIs is unfair. They only took advantage of whatever that was offered to them.

Whether MFIs were lending to first time borrowers or are they double financing the existing borrowers of other banks or other MFIs? Are they informing other Banks/MFIs in case of double financing? Are they ensuring end-use of funds? Are they financing any income-generating activities or consumption activities?

Whether staff of MFIs has any credit assessment skills? Whether MFIs or their staff is doing a risk assessment of the borrower? Whether MFIs are educating the borrowers about the conditions and stiff repayment obligations?

Where is the need for MFIs to target the SHG-Bank Linkage beneficiaries? Whether the staff of MFIs was given stiff targets of lending and recovery in order to boost their turnover? Were these staff adequately trained and sensitized about the rural dynamics? Were the staff paid salaries or given incentives on targets? How did the staff recruitment take place and what are the HR practices of MFIs? Why did their staff behave with borrowers in inhuman manner as alleged? Did not such behaviour warrant the application of other Laws in the country to tackle it?

A joint fact-finding study on microfinance conducted by Reserve Bank and a few major banks made the following observations as mentioned in the RBI Master Circular RBI/ 2010-11/52 RPCD. FID. BC.No. 05 /12.01.001/ 20010-11 July 1, 2010):
i. “Some of the microfinance institutions (MFIs) financed by banks or acting as their intermediaries/partners appear to be focusing on relatively better banked areas, including areas covered by the SHG-Bank linkage programme. Competing MFIs were operating in the same area, and trying to reach out to the same set of poor, resulting in multiple lending and overburdening of rural households.
ii. Many MFIs supported by banks were not engaging themselves in capacity building and empowerment of the groups to the desired extent. The MFIs were disbursing loans to the newly formed groups within 10-15 days of their formation, in contrast to the practice obtaining in the SHG - Bank linkage programme which takes about 6-7 months for group formation / nurturing / handholding. As a result, cohesiveness and a sense of purpose were not being built up in the groups formed by these MFIs.
iii. Banks, as principal financiers of MFIs, do not appear to be engaging them with regard to their systems, practices and lending policies with a view to ensuring better transparency and adherence to best practices. In many cases, no review of MFI operations was undertaken after sanctioning the credit facility.”
These findings were brought to the notice of the banks to enable them to take necessary corrective action where required. If lending to the poor is cost-intensive, and such lending is very necessary in the drive to financial inclusion agenda, the cost needs subvention from either the Financial Inclusion Fund or the Micro Finance Fund and the delivery mechanism for such subvention has to be worked out carefully.
This circular and the entire episode with consequences reflect that the RBI has to bring them into financial regulatory regime as they are also part of the overall financial stability mechanism. NABARD because of its one and half decades of active presence in the micro finance sector through SBL programme, may have acquired the capabilities to regulate the system. But it cannot be a player and regulator and therefore, it may hive off this activity as an independent arm and then take over regulatory responsibility if the RBI were to continue to feel that it is not equipped adequately to handle this regulatory responsibility. Micro Finance Regulation and Development Bill 2007 have been well debated and its ineffectiveness has been articulated in full measure. The Bill drafted by NABARD with the assistance of SADHAN, deserves redrafting as it does not respect either financial regulation or legal fundamentals.
The MFIs’ taking credit for reaching those poor where the institutional credit mechanisms thus far failed to reach has some justification. But the route they chose became questionable. If, as they aver, the poor get the money at the door step and they were able to get a multiplier out of it and therefore the MFIs are reasonable in expecting a major slice of it, is patently absurd. The poor, if they start earning more than what their existing style of living demanded, should be enabled to save a good pie for the future and for better insurance and protection of the next generation. The MFIs that did not create livelihood opportunities, and barricaded sustainability have no license to squander public money in the name of equity. Growth with equity should also be matched with social justice and this is instantaneously absent in the present MFI approach.

Malegam Committee in its wisdom suggested an array of interventions by the regulator and couple of days before its release, the RBI asked “banks to extend the regulatory asset classification benefit to ‘standard’ restructured MFI accounts, even if they were not fully secured. This relaxation banked on environmental factors. The RBI felt that the huge lending to Micro Finance Sector by the commercial banks of all hues, that got classified as priority sector lending because of its earlier classificatory instruction, needed a reprieve failing which the Banks had to provide additional capital. Banks used to resort to Consortium lending to distribute the risks among the group of banks whether small or big and to have an internal discipline in portfolio management. Somehow, the Banks felt that they can give a go-by to this practice even when more than Rs.2000 crores were to be lent to a single NBFC dealing with micro finance because it was lending to priority sector!! The fact that did not attract the attention of the Malegam Committee as well, give the impression that the Banks have lent prudently to the MFIs but landed up in NPAs and therefore required the reprieve.

The Committee’s postulates and assumptions of the nature of clientele were the right triggers of the Micro finance activity. If the RBI were to regulate the NBFCs why did it fail in the first place to distance itself and in the second place giving a modicum of credibility in the name of priority sector? Third, why did it turn a Nelson’s eye when the issues of high rates of interest were repeatedly being brought to its notice for the past three years? There is partial interest rate regulation concerning agriculture and SME sector at 7 percent per annum for the farmer and 9 percent for a section in the later. Would it require the Committee to suggest regulatory interest regime for this sector? There were a few studies which went into the cost of lending in the Micro Finance Sector suggesting comfortable optimum lending rate in the range of 23-24% per annum, as the clientele of the MFIs needed to be cultured into borrowing discipline on one side and to put them into livelihood projects instead of consumptive behaviour on the other. New form of business organization with a clumsy definition in the shape of NBFC-MFI is unnecessary. The existing regulatory rigour if properly administered on the NBFCs would be adequate.

The Committee said that the primary borrowers should be with an income cap of Rs.50000 per annum. If such a cap is linked to inflation index it would have made sense. A dynamic concept has been given a static field. Credit risk assessment and management is the basic job of the lender. The Committee could have specifically narrowed down on the excesses and conflicts of interest and suggested remedies to such practices. Policing is not the job of the financial regulator. It falls within the realm of the Government.

While the AP Government acted in a huff putting an imperfect legislation in its ambivalent situation and in its anxiety to demonstrate that the Government existed and it was capable of preventing nefarious recovery practices driving people to commit suicides. In fact, the existing laws were adequate to deal with such situations. Well, it had little political options at that moment. Malegam Committee excepting to suggest transparency in terms and conditions of sanction of loans under joint liability group approach and relaxed recovery periods – at fortnightly or monthly intervals etc., did not come up with stringent regulatory action on the NBFC-MFIs should they go beyond such practice. The margin cap of 10-12 percent with an outstanding of Rs.100cr at the beginning and end of the year does not really help. It could have come up with the suggestion that each NBFC dealing with micro credit should invest in livelihood projects to the extent of at least 30-40 percent of its portfolio.

Uniform repayment programme at fortnightly or monthly intervals is not going to impart discipline to the lending unless it is linked to the income accruing into the hands of the borrower. For example, take the case of the fishermen. When they come to the shore with the catch once in a week or ten days, they sell it away at the jetty. The fishermen would be too eager to repay but only at that point of time. It would almost be impossible to recover later. The vegetable vendors likewise contracting to buy once in a week could also be happy to repay once in a week while many others find it difficult to adhere to such weekly repayments. The suggestions of the Committee reflect inadequate appreciation of the way the poor respond to credit in various situations.

The Committee failed to address the issue of insurance of the JLG and SHG groups that required appropriate cover both for life and their earnings. The Committee’s Report left more questions than answers. In fine, very few of the recent RBI reports evoked such disappointment as this and the RBI should make up for the shortfalls in the Report.
------------------------------------------------------------------------------------------------------------*The author is an Economist and Member of the Expert Committee on Cooperative Banking, Government of Andhra Pradesh. The views expressed are personal.