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Bank for International
Settlements released a consultative document in December 2015, entitled: “Guidance on the application of the
Core principles for effective banking supervision to the regulation and
supervision of institutions relevant to financial inclusion” inviting comments
before 31st March 3016. This document meant for effective
supervision of the non-banking financial intermediaries is the outcome of a
survey Basel Committee on Banking Supervision (BCBS) conducted a range of
practice survey in 2013 (ROP) on the regulation and supervision of institutions
of relevance to financial inclusion and on financial consumer protection across
59 jurisdictions with 52 respondents.
I have kept the following ground rules in view
while reviewing the Draft Document:
Ø Cost of compliance must be less than
the cost of avoidance.
Ø Regulations and rules must be simple
and straight forward inviting easy compliance.
Ø Multiple regulators impacting on
financial inclusion agenda should be able to strengthen and accelerate the
implementation.
Ø Financial Institutions engaged in
financial inclusion should be able to deal with it as a portfolio for
generating data and information required for proper regulation.
Ø Instruments, tools and techniques of
supervision should be uniform across the nations.
Ø Financial Inclusion achievements
should be subject to social audit as well.
G-20, post recession formed Global Partnership
for Financial Inclusion (GPFI) to ensure the 2bn under-served and un-served or
financially excluded individuals have easy, cost-effective and safe access to
the financial services. “Financial innovation and financial inclusion
can introduce potential benefits to the safety, soundness, and integrity of the
financial system as well as potential risks to providers and customers alike
and the transfer of well-known risks to new players.”[1]
The
document recognizes three elements of change in the financial inclusion
landscape: wide ranging products offered by banks to the hitherto financially
excluded, nature of institutions moving from banks to non-banks and mobile
network operators and the rapidity of the change both in the products and
processes. There is multiplicity of regulators and numerous regulations. Still,
anti-money laundering provisions applicable for the rest of the financial
system are not equally effective while nursing the ‘un-served and underserved’
individuals through financial inclusion products and processes. It came to the
conclusion that nineteen of the twenty core principles outlined in its Guidance
2012 are applicable to the multiple institutions engaged in the financial
inclusion effort and space. These principles of supervision have been amplified
to twenty nine comprehensive, complex and cost-intensive regulations for many
small nations and small institutions.
Indian financial sector offers enough scope for
providing the critique:
India has substantial presence in the global financial
inclusion agenda occupying 5th rank in the globe. While the share of
Asia and Pacific was 88.78% in the outreach in terms of the poorest clients,
India alone accounted for 56.56% and Bangladesh 16.83% which means these two
countries together account for the lion’s share, 82.66%, of this regions
microfinance to the poorest. Over all, India’s is estimated to have 30% share
in microfinance borrowers (poor and the poorest) of the world although its
share in the outstanding portfolio was only 7% of the World (Reuters 2010).
There are fourteen major models of Micro finance that emerged after the Nobel
Lauriat Md. Yunus gave the big push in Bangladesh.
India mirrors the globe in nature, type and
size, diversity and complexity of regulatory institutions. It has well
established rules for coordination through the Financial Stability Regulatory
Board chaired by the Union Finance Minister. Yet it has gaps in perception in
so far as financial inclusion agenda is concerned.
India is at the cusp of change and is at the
epicenter of growth whose stability and policies are material for global
financial stability. When India noticed countries like Philippines and Kenya were
offering best models in financial inclusion it has adapted them. Mobile
financing is making deep inroads into the pockets of the poor. Rupay cards as
retail credit card instrument is also fast apace. Where branch banking has not
been able to effectively reach the poor, business correspondents as agents of
commercial banks are engaged – referred to as third parties in the Draft
Guidelines document.
Starting from the chit funds that still
continue both in the organized and unorganized financial sector sphere in the
country, India is home to all the models of non-banking financial
intermediation that have been mentioned in the BCBS document cited.
Multiple institutions are involved: commercial
banks and Regional Rural Banks that run SHG-Bank linkage program for the poor
targeting savings, thrift, credit and livelihood promotion among the ‘unserved
and under-served’ poor communities, NBFCs, non-deposit based financial
institutions, micro finance, micro credit and micro insurance institutions etc.
There are multiple regulators regulating the
non-banking financial intermediaries in India: Reserve Bank of India;
Securities Exchange Board of India (controlling those companies that are
equity-led with and without foreign institutional participation); Government of
India, Telecom Regulatory Authority of India, Insurance Regulatory and Development
Authority, and Pension Fund Regulatory and Development Authority. Coordination among the regulatory agencies is
one of the issues flagged in the draft document.
Some of the Indian States have their own
agencies like Society for Eradicating Rural Poverty (SERP), Mahila Saadhikara
Samstha (Women Empowerment Society), Kutimba Sree etc that are providing grant
and interest subsidy support for the livelihood programs organized around them.
RBI treats lending to these groups as priority sector advance and exempts KYC
of individual accountholders if the office bearers’ KYC is obtained. RBI also
clarified that presence of defaulters to the financing bank in SHG that is not
a defaulter should not deter the financing bank from lending to the SHG
further. Government of India in its budget 2008-09 clarified that the banks
should embrace the concept of financial inclusion by meeting the entire credit
requirements: ‘(a) income generation activities; (b) social needs like housing,
education, marriage etc., and (c) debt swapping.’
Prime Minister’s Jan Dhan Yojana (PMJDY)
launched on 15th August 2014 as a major driver for financial
inclusion saw the banks opening 140mn accounts in one and half years as
compared to around 7mn basic savings bank accounts from 2005 to 2014. PMJDY
also envisaged a per account credit of Rs.5000 after six months of opening the
savings bank account. Banks were found to be moving cautiously on this account
going by the 0.65 percent of the PMJDY accounts alone getting such credit
facility.
The states have competing and sometimes
conflicting interests with the financial regulator. When a few borrowers of
MFIs committed suicides allegedly due to excesses in recovery of dues, Andhra
Pradesh (2011) enacted a Law preventing the MFIs from charging interest rates
higher than those stipulated under the Act and also to exercising right to
treat any forceful recovery as extortion punishable as criminal offence on the
part of MFI. MFIs in the State almost collapsed. Several Banks that lent to the
MFIs had to take a severe hit in their provisions as such MFIs became NPAs with
primary borrowers defaulting on their commitments. RBI later appointed a
Committee under the Chairmanship of Malegam, Director of the RBI Board and a
Chartered Accountant to examine the issues and suggest solutions. The Committee
prescribed the ceiling on lending rates of MFIs: 26% per annum. It took nearly
three years for the MFIs to become active players. There are equity based
institutions and donor based institutions; there are savings and thrift led
institutions; and there are livelihood and insurance institutions in the micro
sphere.
National and State Governments, financial
institutions, non-banking financial institutions and organizations, MFIs – both
donor and equity based, financial cooperatives are all moving simultaneously to
flood the financial inclusion effort. Delivery channels include the traditional
savings bank, business correspondents, credit, insurance, pension payments,
credit card and mobile banking of any and all the above institutions. All these
are licensed entities of either the Government or the RBI.
The complexity of institutions does therefore
exist. As rightly mentioned in the document, the nature, size, geographical
space, and the multiple products and processes need regulation of a different
alchemy.
Smaller nations pose lesser problems in risk
assessment, risk management. Governance and regulation in the sphere of
financial inclusion than countries like those in South Asia and China.
Therefore, document presenting the supervisory principles with a broad brush is
like a broad spectrum antibiotic.
Further, when 19 of the 29 core principles need
to be followed, without their reference to specific geographic location or process,
the principles seemed academic. Had the document contained a tabular statement
of the nations that already have in position a separate law to deal with
MFIs/NBFCs distinct from the financial regulator – the central bank and the
nations that have government alone as regulator of such institutions as
licensing authority, the section 3.1 dealing with ‘powers, responsibilities and
functions’ would have offered a better guide for institutions to go from where
they are to where they should be moving.
‘The primary objective of supervision of
banking supervision is to promote the safety and soundness of banks and the
banking system’ and financial inclusion agenda should not come into conflict
with this objective. The supervisors with financial inclusion responsibilities
are expected to hedge the ‘exclusion risks to the soundness of the financial
system, less transparency, financial integrity, greater macroeconomic
volatility and higher social and political instability.’ The moot question is –
can the supervisor with the best of training hedge the above risks? Why did it
not prescribe the boundaries of transparency?
The second principle dealing with Legislation demands
that “the Law should ensure that supervisors have powers and operational
independence to carry out proportionate and effective supervision of such
institutions without government or industry interference (EC 1). Similarly, in
order to avoid industry interference and institutional conflicts of interest,
supervisors must not have management responsibilities in the financial
institutions they supervise (eg in some countries, the central bank may be
involved in key decisions regarding the activities of state-owned financial
institutions, including development banks and microfinance institutions). As a
general rule, supervisors should not have responsibilities to promote or
develop a sub-sector of financial institutions that they supervise.” There is
no illustration as to which country has such Law in place. This looks utopian
as the government may not have this as a priority item on its agenda. The
Government on the other hand, may feel that the central bank has enough
capacities to take care of this aspect and it is enough if it does not
interfere with the financial regulator. In countries like India where the
central bank scrupulously reviews the financial stability at agreed intervals
and indicates the supervisory actions in response to the identified
situations, a separate law by itself may
not be necessary.
Where
the central bank discharges both the developmental and regulatory
responsibilities it called for separate it called for separate institutional
arrangements with clearly delineated objectives between them and adequate
financial resources to deal with them independently. The skill sets, manpower
required for both the functions impose heavy financial burden on the regulator.
It is unclear as to who will have to provide such resources? Should they come
from the government budgets annually or from the regulator or from the
institutions that are implementing the financial inclusion agenda? If this
aspect is left for the government to decide, who should bear the compliance
burden of this rule?
The third principle – cooperation and
collaboration between the multiple regulators is indeed very necessary.
Financial Stability Regulatory Board of India should be able to take care of
this aspect. But this is easily said. Each Regulatory Authority has powers and
responsibilities well defined and would feel uncomfortable when one or the
other regulators calls for compromising such authority in the interest of
financial inclusion risk management.
“The prudential supervisor may also
pursue coordination and cooperation mechanisms with: (i) the financial
intelligence unit, with respect to customer due diligence requirements and
monitoring; (ii) foreign authorities to identify and address stability threats
arising abroad; and (iii) authorities in charge
of regulation and supervision of nonbank financial institutions as well
as functional supervisors, where relevant, to expand participation in the
financial stability policy arrangements.”, the report argues. Considering the
size of financial inclusion effort’s impact on the involved institutions’
balance sheets, is this not an overdose of supervisory responsibility? Would it
not be prudent to insist on the respective supervisor to make it an important
aspect of regulatory responsibility and provide periodical confirmation in this
regard?
Permitted activities and
licensing requirements can actually be subsumed into one principle. Licensing
requirements can specify the permissible activities.
Supervisory approach depends upon
the risk profile of the institutions concerned. While being so, risk management
practices should be well defined and regulated by the Board. It is governance
that becomes more important to ensure effective supervision.
For example, in issues like governance, the
supervisory principle should have been quite prescriptive: there shall be a
written confirmation regarding the commitment of the directors over previous
defaults; the raison de ‘etre for being on the board of the NBFC/MFI/Bank and
what he/she would contribute during his/her tenure towards the financial
inclusion agenda of the institution etc.
The Principle relating to ‘Supervisory
techniques, instruments and tools’ have been very elaborate. If these are
followed, it obviously follows that the deficiencies if any are reported for
review and timely correction. Key responsibility indicators “should
allow the supervisor to assess portfolio quality, loan loss provisioning, risk
concentrations, capital adequacy, operating costs, funding structure and
liquidity position, foreign exchange exposures, and interest rate re-pricing
gaps. Supervisors should have the ability to compare key indicators against
performance benchmarks within peer groups.
Reports of internal and external
auditors may also be used to collect information about particular activities in
supervised institutions.” Supervisors, in other words, should be encyclopaedia.
Each of the above activities requires special skill sets. Combining them as
essential ingredients of a supervisor the BCBS failed to draw the distinction
between the financial inclusion outcomes with that of the general banking
requirements. The recommendation borders on improper expectation.
There can however be no two
opinions on the need for supervisors to verify and validate the data released
by the involved institutions. Data integrity even otherwise is a major issue.
The supervisor must be able to fix accountability for submission of the correct
data. One of the major weaknesses of the existing financial systems is the
unverified data. Clean data is important for correct policy prescription. It is
highly desirable that wrong data submission is penalised.
The Document fails to draw
distinction between supervision and audit/inspection. Supervision is superior
to audit/inspection. If the auditors fail to report irregular practices, they
should also be accountable to the supervisor. The supervisory action as a
surveillance mechanism post audit should necessarily allow for superior
punishments that include not just monetary penalties but cancelling license to
carry on the related businesses. But such action should be weighed in relation
to the client protection norms. The clients in this case – the financially
excluded community – cannot afford the consequences of the institutional
maladies noticed by the supervisor worthy of such punitive action.
Insurance/re-insurance/guarantee mechanisms should be in place to secure and
protect the clients’ interests.
The Committee’s warning: “Supervisors
designing corrective or sanctioning measures must therefore have a good
understanding of the specific dynamics of traditional micro-lending, so that
the supervisory measures do not lead to unintended and undesirable consequences,”
is very appropriate. This ipso facto requires that the supervisors of financial
inclusion institutions should be different and differently equipped to perform
the tasks expected of them.
Financial Cooperatives, going by
Indian experience, suffer from several inadequacies and imperfections both
under law, regulation, supervision and management. It has multiple regulators
and the state regulator is a victim of political interference and does not also
have adequate knowledge to deal with financial products and processes unlike in
the rest of 19 countries in G-20. RBI as the financial regulator has brought
them under its licensing fold both the rural and urban cooperative banks. It
may be easier to cancel the license in case of deviation from the regulatory
norms but will still find difficult to impose financial discipline on them. The
requirements spelt out in the document are but appropriate.
Consolidated supervision makes
lot of sense in the context of banks financing cooperatives, NBFCs, MFIs, MFOs,
or holding their accounts as operating accounts or deposit accounts, even if
not lent, Business Correspondents (third parties whose businesses are insured
to the extent of their daily cash collections from the basic account holders of
the banks).
Strange indeed are the risk
management practices painted with the same brush as that of the other financial
institutions and not specific to the inclusion agenda pursued by the respective
institutions. Credit, market and operational risks in relation to the
institutions pursuing financial inclusion goals pose different when mapped in
relation to the quantum. It is more operational and systemic risks that pose
severities and these require particular attention. Retail lending in
‘inclusion’ credit markets is for short tenure and creation of durable assets
in the hands of the clients is not so significant as to cause worry if there
are no problems in due diligence and credit origination. Monitoring the loans
regularly would generally ensure that repayment cycles are not adversely
affected unless natural calamities overtake them. Deposit and credit insurance
mechanisms are adequate enough safeguards to mitigate the credit risks. The
elaboration of the nature mentioned in the document seems an overstatement of
the concern.
In so far as Capital adequacy is
concerned for those institutions dedicated to financial inclusion the standards
specified by the BCBS at Basel 1 or Basel 2 capital adequacy standards are
certainly adequate. If the commercial banks lending to MFIs/NBFCs do not due
diligence in their eagerness to reach the targets of the priority sector as has
happened in 2010-12, credit and market risks are going to be as serious as for
high volume corporate lending. Capital provisioning should be of higher order
than the normal prescription and should conform to Basel III prescriptions.
Specific problems require specific solutions.
The proportionate approach that formed the assessment of compliance of the Core
principles of supervision in 2012 is found wanting in this consultative
document. In all, there is scope for retaining only ten of the 29 principles
enunciated in the document.
*These comments were posted on BCBS Comments page.
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