10
Feb

Credit Information Reporting for Self Help Group Members

By Irene Baby, IFMR Finance Foundation

The RBI Committee on Comprehensive Financial Services for Small Businesses and Low Income Households (2014) recommended that the regulator require all loans provided by regulated institutions to be reported to at least one credit bureau. Till recently, only banks and NBFC-MFIs were mandated to do so, leaving out of the ambit non-MFI NBFCs, certain categories of banks, and cooperatives. As there is an urgent need for credit bureaus to tap into all sources of credit information in order to build credit histories of people, the Committee recommended that universal reporting to credit bureaus should be mandated for all loans, both individual and Small and Medium-Sized Enterprises (SMEs), but in particular Self-Help Group (SHG) loans, Kisan Credit Card, and General Credit Card. The need for reliable credit information on SHG borrowers is also echoed in the Report of the Expert Group on Setting Up a Developmental Financial Institution for Women SHGs (2014), as well spoken of by Ms. Kalpana Pandey, the CEO and MD of CRIF High Mark, one of the credit bureaus[1].

Taking cognizance of these recommendations, the Reserve Bank of India, in its circular on Credit Information Reporting in Respect of SHG Members, issued on 14th January, 2016, has mandated all scheduled commercial banks including regional rural banks to collect and report credit information of individual SHG members to Credit Information Companies (CICs) beginning from 1st July, 2016. A two-phased implementation approach to the RBI directive has been suggested with emphasis on the quality of data collected and reported. Phase I will commence from 1st July 2016, and phase II from 1st July 2017. The depth of the credit-related information to be collected would increase in phase II[2]. The implementation process will entail separate collection of information for SHG members whose total amount of loan that exists or to be availed: a) exceeds Rs 30,000 and b) is up to Rs 30,000; with the information requirements of the former being more detailed than the latter.

The information to be sought from SHG members can also be classified as:

  • Credit Information: This information is to be collected and reported only for members of those SHGs that avail bank loans exceeding Rs 100,000. Information about existing exposure, including loans from SHGs that individuals were associated with in the past may be collected by banks directly from the CICs based on lead information provided by SHG members.
  • Non-Credit Information: This will be collected and reported for members of all SHGs, regardless of the amount of the group-loan. This will be done through the SHG group at the time of opening of new Savings Bank Accounts of the SHG.

To ensure that banks adhere to the regulation effectively, the RBI has also directed that the non-compliant SHG loan accounts will be excluded from the banks’ loan portfolios eligible for the purpose of complying with the Priority Sector Loan (PSL) targets.

The SHG model is an important credit delivery channel for increasing access to finance, with loan outstanding for 2014-15 at Rs. 526.3 billion across 4.49 million loans. While the number of loans disbursed under the SHG-Bank linkage during 2014-15 increased by 26%[3] from 2013-14, this growth has been largely driven by loans under government programmes (like National Rural Livelihoods Mission (NRLM) and Swarnajayanti Gram Swarozgar Yojana among others) which alone increased by 175% during the same time period.

In order to develop the SHG loan as an asset class with adequate market signalling mechanisms to indicate its true nature of risks and returns, easy access to reliable information on portfolio quality would be vital. The RBI has in effect initiated a concerted system-driven effort to capture both group and individual loan level details and to report to credit bureaus. Individual credit reporting has been successfully implemented for JLG loans and replicating it for SHG loans- including capturing information on netting off of any savings account balances upon default – would be pivotal to qualify the SHG as an asset class that financial markets can build meaningful depth in.

These new RBI regulations can also be expected to prevent and reduce instances of over-indebtedness of individual customers. Given that the revised MFIN Code of Conduct has mandated a transition towards the compulsory use of Aadhaar card for microfinance lending in the next 2 years, and has agreed to share complete client data with all RBI approved Credit Bureaus, these new RBI mandates on reporting credit information of SHG members will be a crucial enabler in enriching ‘thin-file’ clients credit histories and increasing their ability to access formal credit.



[1] ‘Banks not reporting credit information of individual members of self-help groups’, Hindu BusinessLine, January 14, 2015
[2] In phase I, the status of the SHG member’s loan account is to be enquired only if the SHG account was in default. In Phase II, the status of the SHG member’s loan account is to be enquired if the SHG loan was distributed to him/her regardless of the status of SHG loan account.
[3] Inclusive Finance India Report 2015

1
Feb

Simulating Housing Choice for Low-Income Urban Households

As part of IFMR Finance Foundation’s “Notes on the Indian Financial System” research series, Anand Sahasranaman, Vishnu Prasad & Aditi Balachander, have authored the latest research note on “Simulating Housing Choice for Low-Income Urban Households”.

Abstract:

It has been argued theoretically that the nature of risks confronting low-income households – income volatility, wealth allocation and the need for mobility – makes them unsuited to mortgage-based ownership housing. Testing this theory by mathematically simulating the effect of these risks on the wealth of a stylised urban low-income household over a twenty year period, we find that rental housing minimises the risk of undesirable wealth fluctuations of the households and is a much more appropriate housing proposition for low-income households, thus corroborating the theoretical arguments. In view of our results, we believe that the policy environment must incentivise the creation of rental housing solutions for low-income households.

Click here to read the note.

22
Jan

Microfinance through a Data Lens

By Vaibhav Anand & Aryasilpa Adhikari, IFMR Capital

In the last five years, the microfinance sector in India has grown into a stable and well-regulated sector thanks to a strengthened regulatory framework and credit bureau infrastructure. The regulatory oversight on NBFC MFIs and the advent of the microfinance credit bureau infrastructure with mandatory reporting requirements have made it possible to go beyond anecdotal evidence and analyse these issues in a robust manner which is the objective of this post. NBFC MFIs are generally registered with Equifax and/or Highmark to do credit bureau checks and report credit information on their portfolio periodically. Under RBI guidelines, NBFC MFIs cannot lend to a customer who already has two MFI lenders or whose total indebtedness exceeds INR 1,00,000. Gaps in the information available on bank lending to microfinance clients through the Self Help Group (‘SHG’) model are expected to be addressed over a period of time as banks start complying with the recent RBI guidelines relating to bank reporting on their SHG portfolio. NBFC MFIs also make higher provisioning including on standard assets of 1%. The silos in credit bureau market infrastructure are also expected to reduce as all credit institutions start reporting information to all credit bureaus under the guidelines issued by RBI in January 2015.

How far has the microfinance sector come since 2010? What is the quality of growth of rapidly growing MFIs? Is growth adversely affecting customer well-being? In this post, we attempt to understand these issues based on rigorous data. Given that a large proportion of excluded Indians, women in particular, depend on MFIs for their only source of financing, conclusions must be drawn with a great deal of responsibility.

Sources of data/information

Field observations discussed in this blog are based on over 200 field surveillance and monitoring visits conducted by IFMR Capital since April 2013. During these regular visits, the team covered more than 1000 microfinance centre meetings across 200 districts and 20 states, including interview-cum-discussion meetings with branch managers, loan officers, JLG borrowers and senior management at Head Office.

The microfinance sector performance data discussed in this blog is based on mainly two sources: (a) Microfinance sector level pincode reports for more than 500 districts subscribed from Equifax, one of the largest microfinance credit information bureaus in India, and (b) Performance data on microfinance portfolio based transactions, with underlying microfinance loans worth more than INR 3500 crores, structured by IFMR Capital.

Question 1: Is pipelining rampant?

Credit pipelining is the practice of borrowers routing the availed loan amount to another person, who may be a member of the group or a third person, referred to as beneficiary. The beneficiary usually uses the money for her/his own purpose and makes periodic repayments through the group. In lieu of their KYC and attendance at the centre meetings, borrowers may receive compensation (commission) from the beneficiary. If repayments are regular, it is difficult to identify such cases; it is only when the beneficiary is under financial distress and he/she finds it difficult to repay instalments, that pipelining is discovered. Such pipelining incidences are neither uncommon nor limited to a particular district, region or state. Credit pipelining, as discussed subsequently in this blog, is often a result of operational process dilution. Sporadic cases are observed across states during regular monitoring visits by IFMR Capital.

The recently highlighted instances (link) of credit pipelining and multiple lending, and events which unfolded subsequently in a village in Eastern UP are extremely unfortunate. Such instances undoubtedly require prompt and effective corrective action that must be institutionalised at the highest levels in an MFI. We completely disapprove practices that result in such instances and our position towards these is enshrined in our underwriting guidelines. While we continue seeing sporadic episodes across the country, our field analysis and data however don’t support the wide-spread nature of such issues. Based on pincode level data, we drilled down to district level and looked at the trend of portfolio performance, portfolio growth and multiple lending for the three eastern UP districts in recent focus – Azamgarh, Chandauli and Varanasi.   The data does not show evidence of excessive multiple lending by MFIs in these districts with less than 3% clients having more than two MFI loans.

Img1_1_MFPImg1_2_MFP
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Portfolio growth, proportion of clients with more than two MFI loans and delinquency levels in Azamgarh, Chandauli and Varanasi
*Source: Equifax

It is important to note that the underlying factors behind pipelining as well as the mitigating steps needed to curb pipelining are not new to the sector. Though it is true that pipelining is difficult to uncover, sooner or later such cases result in repayment delays by the involved members bringing these to the attention of the lender. Credit pipelining is often seen in centres where some or all of the following factors are present: (a) borrowers are not aware of the consequences of payment default such as negative profile in credit bureau and possible denial of credit in future, (b) Loan utilization checks are weak, (c) dilution of group formation and origination processes such as group recognition test (GRT) and continuous group training (CGT) and (d) MFI loan officer’s reliance on a single centre member (‘centre leader’) for centre operations such as group formation and collection of payments during the centre meeting. It is true that increasing competition and pressure to raise loan officer productivity may result in dilution in key processes and reliance on influential centre lenders.

In our discussions with management during monitoring visits, we have found that MFIs are aware of the underlying factors which result in such incidents and are increasingly focusing on mitigating mechanisms such as (i) Ceiling on origination linked incentives for loan officers (ii) disbursement conditional on strict compliance to CGT and GRT (iii) residence verification and meeting borrower’s family or spouse to ascertain loan utilization and to restate implications of credit default (iv) adherence to loan utilization checks (v) compliance to credit bureau processes and (vi) strengthening internal audit.

Question 2: Is there overheating?

Another concern discussed often in microfinance is over-indebtedness and the issue of borrowing by JLG members from multiple sources including MFIs. During monitoring visits to our NBFC MFI partners, we have observed a very high compliance to regulatory guidelines on multiple lending and borrower indebtedness across the sector. While the challenge posed by the usage of multiple KYCs by borrower is not unfounded, our understanding is that the prevalence and impact is limited. In addition to KYC identifiers, microfinance credit bureaus also rely on advanced algorithms to track borrowers in their database by matching borrower name, spouse or relative name, address string and address pincode. Based on the loan level portfolio scrub data queried from one of the credit bureaus, we observed that same client with different KYC documents and ID numbers was identified based on name and address string. Such algorithms reduce the risk of multiple lending due to multiple KYC IDs, alerting the lending institution on matches found in the credit bureau information even when different KYCs are used.

We used pincode level microfinance loan performance data available for nearly 6000 pincodes across more than 500 districts, to measure the prevalence and impact of multiple lending. We define multiple lending as availing of more than two MFI loans by a single client at a given time. We measured multiple lending in a district as the proportion of clients with more than two MFI loans.

Our findings suggest that a median multiple lending of 2.35% and 1.50% as of Mar-2015 and Mar-2014 respectively. For 90% of districts, which incidentally also account for 90% of microfinance portfolio, the multiple lending measured is less than 9% as of Mar-2015 (up from 6% as of Mar-2014). It should be noted that our measure of MFI multiple lending is fairly conservative. Even during monitoring visits, we often see clients with three MFI loans. One of the primary reasons is the lag between the disbursal of a new loan and its reporting to the credit bureau by the MFI. During such period, the client may receive loan from another MFI (or MFIs) as credit bureau check may not show the existing loans accurately in the short transition period. However, the prevalence of this operational issue is limited. With many NBFC MFIs moving to weekly sharing of performance data with credit bureaus, we expect to see a decline in multiple loan instances due to such operational reasons.

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Proportion of more than 2 MFI loans in districts
*Source: Equifax

We also checked for the microfinance portfolio being originated in districts with different proportion of multiple lending. In simple words: are districts with higher multiple lending contributing disproportionately more to the sector portfolio outstanding? The graph below shows that nearly 90% of portfolio is originated in districts where less than 9% clients have more than 2 loans from MFIs. Similarly, nearly 95% of portfolio is originated in districts where less than 15% clients have more than 2 loans from MFIs. Certainly, this data does not account for loans taken by borrowers under SHG scheme as well as loans from non-NBFC MFIs, private money lenders, and other such sources which do not report to credit bureaus. Also, the data may include limited microfinance portfolio originated by banks through business correspondents.

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Cumulative portfolio contribution by districts with multiple lending

*Source: Equifax

Additionally, we also look at portfolio performance in districts with high proportion of clients with more than 2 MFI loans. We found little overlap between the top ten percentile districts with highest delinquencies and districts with highest proportion of clients with more than 2 MFI loans as of Mar-2015.

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Top 10 percentile districts: Delinquency vs Clients with >2 MFI Loans

*Source: Equifax
**Grey dots show districts with MFI presence. The representation is to show microfinance presence and is not an official map of the country or state.

Question 3: Is growth affecting credit quality?

We looked at data to see if higher growth would result in process dilution and subsequently lower quality portfolio. The performance of microfinance portfolio transactions structure by IFMR Capital shows a significant improvement over the last few years.

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Loss and Default percent on microfinance portfolio transactions structured by IFMR Capital (based on 286 pools underlying loans worth INR 3.5 thousand crores)
*Source: IFMR Capital

Sector level microfinance performance data also substantiates a stable and healthy growth for the sector. Based on the district level portfolio growth from FY13-14 to FY14-15 and fresh delinquency occurrence (loans overdue by 0 to 180 days) as of FY14-15, we identified the top 10 percentile and top 20 percentile districts in both categories. One would expect that if portfolio growth is unrestrained in a district, it would result in higher delinquency. We found little overlap between the two group of districts, i.e. top growth and top delinquent districts, suggesting that growth is higher but not unrestrained, and is not necessarily resulting in process dilution and subsequent lower quality portfolio.

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Comparison of top portfolio growth and top delinquency districts
*Source: Equifax
**Grey dots show districts with MFI presence. The representation is to show microfinance presence and is not an official map of the country or state.

Findings

Our data does not support wide-spread prevalence of pipelining or over-lending. Neither does it support deterioration in portfolio quality due to growth. The effective implementation and usage of credit information bureaus by MFIs is key to controlling these issues. Challenges related to KYC documents of borrowers exist. Using technology, credit bureaus have tried to address this problem by matching borrower and spouse names as well as address strings to identify duplicate borrowers in the system. Further, to mitigate the risk of using multiple KYC documents, MFIN has provided guidelines to all member MFIs to adopt the Aadhaar number as the unique KYC identifier over the next two years. There is also a need to bring other sources of credit in the formal regulated regime. Credit performance data under the self-help group (SHG) program should also be brought onto the credit bureau reporting system to ensure complete visibility on indebtedness and credit performance. In a significant step towards ensuring this, RBI recently issued another circular (link) directing banks to complete reporting of SHG data to credit bureaus in two phases by July 2017.

18
Jan

Assessing Suitability – What’s the future for financial providers’ legal duty of care?

By Malavika Raghavan, IFMR Finance Foundation

In the previous blogpost we noted the gradual shift away from the buyer-beware standard in case law and policy regarding customers of financial products. So far this move towards more provider liability has occurred in a piecemeal fashion – through decisions of the courts and regulations of certain regulators. For the first time in Indian law, the draft Indian Financial Code (IFC) is proposing a statutory obligation of this kind when it comes to retail financial services. Providers offering products and services in the course of day-to-day retail financial services business (such as discussing a loan with a borrower) will have to begin undertaking an “assessment of suitability”.1

Separately, the RBI’s Charter of Customer Rights has enunciated five customer rights including the “right to suitability” i.e. the right for customers to be offered products appropriate to their needs. The RBI has advised banks to formulate a board-approved policy incorporating these rights into their business process, along with monitoring and oversight mechanisms for ensuring adherence.2

As the movement towards more provider-liability grows, we pause to ask:

Could requiring higher standards of conduct from retail financial advisors fundamentally shift the legal duty of care we expect from them? Will these change the standards of civil liability in tort law that retail financial services providers are subject to?

Wider civil law liability under tort law operates over and above contractually-agreed terms and conditions between financial services providers and customers. This question is important because it could subject financial services providers to a higher legal standard of care irrespective of the contractual terms of their products.

Could we foresee a future where Indian tort law begins to recognize a higher standard of care for financial services providers?

Currently, customers of products can raise claims against faulty products or poor service through a range of legal avenues. These avenues can arise from:

  • Written legislation or statutes which give customers rights (like the Sale of Goods Act, or the Consumer Protection Act),
  • The specific contract between the provider and the customer (in the case of financial products, the product’s terms and conditions),
  • Civil liability under tort law where a “tort” or civil wrong arises from a breach of duty (independent of any contractual breach) for which an action for compensation can be pursued,
  • Through criminal law (for e.g. financial crimes like fraud or criminal breach of trust),
  • And finally, by approaching courts when customers feel that fundamental rights guaranteed by the Indian Constitution have been infringed (especially in cases involving public financial institutions).

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Tort law – a branch of civil liability that has evolved from judge-made common law – has continued its development in Indian courts. Of specific relevance to our current discussions, is the tort of negligence which deals with loss or harm caused by the careless or unreasonable conduct by a person to another. For an act or omission to constitute the tort of negligence, there must have been (i) a legal duty of care that one party owed to another party (ii) a breach of this duty (iii) which results in the other party to suffer loss or damage as a result.3

To understand the duty of care that is owed by the allegedly negligent party in any situation, the standard applied is of the “reasonable person” i.e. whether a reasonable person in the same situation would have acted differently. This objective standard is raised for people performing actions which require special skills, such as doctors, lawyers, financial advisors or accountants. These types of service providers have their actions or omissions compared to a reasonable skilled person within their discipline, rather than the average person on the street.

It is foreseeable that the regulations implementing suitability requirements under the draft IFC will require specific training for providers’ staff to help them assess suitability of products. This is the case in the UK, for example, where the regulator expects firms to have internal systems to manage suitability requirements, including training customer-facing staff to understand the boundaries between advisory and other services, and undertake suitability assessments.4 The draft IFC appears to be moving towards engendering a process-oriented approach for assessing suitability by providers. The Indian Banks’ Association’s Model Customer Rights Policy, formulated at the RBI’s behest, also makes several references to appropriate training of staff. As we know anecdotally, retail advisors already hold weight when recommending products and services to customers. Requirements for advisors to undertake training could add to the manner in which they are perceived to be people of higher knowledge and skill, and raise the duty of care when they interact with customers. This is especially given that in the IFC, “advice” is defined widely to cover any communication directed at the consumer which could influence the consumer’s transactional decision making.5 Any higher duty of care for staff of providers would obviously not apply to non-advisory tasks which don’t require an exercise of discretion (like basic bank teller functions).

It’s important to note that moving towards a higher standard of care for the staff of providers would not make them the scape-goat for all financial losses customers suffer. If market forces affect the returns from products, providers can’t be held responsible for this. As a parallel, we do not hold doctors liable if the patients’ body rejects a kidney. However, the law does expect the doctor to have used the same diligence in the treatment and operation as another doctor of the same skill would have.

Likewise, if customers provide false information then providers can’t be held liable for improper advice. Under tort law, the doctrine of unclean hands would give providers a defence against customers who act in bad faith. Additionally, contributory negligence is a principle in tort law that would protect providers where customers through their own actions contributed to the harm they suffered. The draft IFC also absolves providers of responsibility in the case of information about customers’ personal circumstances which was not obtainable despite “exercise of professional diligence”.6

In conclusion, the question of whether retail financial services providers providing advice and recommendations to retail customers should implicitly owe a higher standard of care to customers is one that beckons tantalizingly in Indian tort law. It will be interesting to see if the general trend towards provider-liability for financial services will reimagine deeper civil liability standards for providers in India. Such a development could be one more piece in the armour of customer protection law in India.

This is the concluding post of the series which you can access in full here.


  1. Section 120(1) of the draft Indian Financial Code, draft released 23 July 2015, Available at < http://finmin.nic.in/suggestion_comments/Comments%20on%20Draft%20IFC.asp> (Accessed 15 January 2016) (Hereafter the “draft IFC”).
  2. http://www.ifmr.co.in/blog/2014/12/04/suitability-becomes-a-customer-right/
  3. For an accessible text (available free at the time of writing online) see Part III (The Tort of Negligence) of Jenny Steele, Tort Law: Text, Cases and Materials (3rd edition 2014, Oxford University Press) Available here. (Accessed 15 January 2016).
  4. Practical Law, FCA Suitability requirements: COBS 9, Available here. (Accessed 15 January 2016).
  5. Section 2(6) of the draft IFC.
  6. Section 120(2) of the draft IFC.

4
Jan

Reaching the Last Mile in Financial Services Delivery

As part of Business Today Magazine’s 25th Anniversary issue, Bindu Ananth has written an article in the latest edition of the magazine. Below is an excerpt from the article:

I write this from the sidelines of my city’s (Chennai’s) worst flooding in 100 years that has rendered lakhs of people homeless and bereft of livelihood. As the daunting task of re-building looms ahead, one key issue, among others, is going to be how to provide people timely and reliable access to financial services? Can we rapidly honour claims related to life, accident and asset insurance, enable withdrawal from savings deposits to meet the immediate need for food and medicines, and provide people short-term liquidity to repair leaky roofs, pay school fees and re-stock inventory? These are “moments of truth” for those offering financial services and, unfortunately, we are too often found lacking. A lot of this can be traced to fault lines in the last mile of financial services delivery.

The last mile is the “plumbing” that connects financial product manufacturers – banks, insurance companies, mutual funds, etc – to their end-customers, that is, households and businesses. While for most of us who belong to the urban, salaried segment, this access is rendered through bank branches, ATMs and insurance/investment agents, the picture looks very different for the rural agricultural segment and urban informal sector workers. They rely far too often on friends and family and informal sources to meet their financial service needs, because as far as they are concerned, the last mile is broken – the nearest bank branch is too far and there is no reliable process to file an insurance claim. For instance, the All India Debt and Investment Survey (AIDIS) 2014 found that about 19 per cent small farmers rely on non-institutional sources for loans despite the well-documented concerns over the costs of such borrowing. It reveals that more than a third of non-institutional borrowing is at annualised interest rates higher than 30 per cent. The problems with the last mile can be broadly attributed to the high cost of providing the service and human resource challenges. I will briefly describe each of these.

To read the full article click here.