On November 22nd and 23rd, IFMR Capital held its first partners meet, a two day meet with all its partners to re-envision access to finance for institutions that impact low income households. Industry participants and researchers came together to discuss a broader vision for the industry. While the two day event saw active participation and debate on issues that currently concern the sector, the emphasis of the meet was largely on the way forward. Held at a critical juncture, participants brainstormed and discussed strategies for reshaping the sector towards a shared vision.

The meet followed the appreciative inquiry format and drew out the best from the participants. The first part was designed to shift the focus of participants from being short-term reactive to long-term proactive. The second part focused on the positives of the industry and on what was valuable about the way the sector has functioned in the past. The participants broke into groups of two and interviewed each other. Each person described their high points and success stories, sharing instances of how and why being in this sector made them feel glad they belonged here.

The third part of the approach sought to use the output from the interviews to get a clear sense of what were the most important factors that contributed to the success in the sector. Later, organised in groups of six, participants worked on a vision of what the sector would be like in five years if the root causes of success were leveraged in specific areas of focus such as governance, customer focus, risk management, product development, etc. The end result was a shared vision that institutions in the sector could look up to.

Some important questions that emerged during the meet are listed below:

1. How should we position MFIs so that they become an indispensable part of the financial system?
2. How do we engage with the political groups more effectively?
3. What are the unique and additional responsibilities of MFI boards, given that they deal with a segment that is financially and otherwise excluded?
4. As a sector, what data do we need to collect and disseminate, internally and externally, to enable holistic risk management?
5. What investments in training will organizations and the industry make in:
• Moving from mono-line to a multi product model
• Ensuring common minimum values are shared across the sector
• Taking on the new role of a financial advisor
6. How do we use technology or other disruptive methods to dramatically improve operating efficiencies?
7. What is the regulatory framework which will allow MFIs to flourish and serve a wider range of financial needs?
8. How do we resolve short-term funding & liquidity issues for the sector?

In the last part of the meet, the groups focused on developing tactical strategies on four areas : brand management, product development, political engagement and ensuring common minimum values, areas that needed immediate action to take the industry from where it is today to where the group would like to see it in the future.

Here is a brief summary of the themes that emerged from the meet.

a) Customer centric approach: The MFI industry’s main strength is its ability to reach out to and serve a vast number of clients. Client engagement is continuous and services provided are valuable. There was a clear consensus that going forward this customer centric approach must continue to be of key importance.

b) Innovation: Every growing sector continuously evolves. Institutions must be able to respond to the changes in the sector. The need is for an innovative and flexible approach which ensures sustainability and works in the interest of its end customers. The idea of MFIs offering multi-products was discussed at length. This was the way forward and MFIs must invest time, effort and capital towards this. MFIs already possess large amounts of granular financial data pertaining to their clients. This could help them understand the needs and capacities of their clients better and in turn aid the design of relevant financial products.

c) Operating efficiencies: The cost to serve low income households can potentially be dramatically reduced by disruptive innovations. Key pieces of infrastructure such as the UID have the potential of making KYC a public good. Enormous strides in technology such as the use of biometric identification, automated payment systems, mobile technology with improved authentication through the UID can also ensure that local branch staff leverages technology to perform their most repetitive day-to-day tasks, freeing up their time to perform their core duty of understanding the needs of clients and recommending appropriate solutions. There was a clear consensus that business models need to evolve and leverage such innovations.

d) Importance of the mission: While sustainability of business was crucial, it was agreed that the commitment to social and economic well-being of the client was crucial to the sector. Given the profile of the average client, MFIs perform the important role of giving access to finance to the most excluded segment of society. Going forward, organizations must not lose sight of this fact. Further, it is necessary that there is an alignment of objectives and vision across the entire company.

e) Positioning of the industry: Concerns were raised about the response of the industry to the recent crisis and the lack of a unified voice. The role of the board was stressed in this respect, many felt that the board should play a role in ensuring customer metrics are tracked continuously and senior management is held accountable to performance as measured against the metrics. This would also ensure that MFIs are collecting enough information during good times as well as bad, so an accurate picture can be presented to the media, investors and regulators.

f) Holistic risk management: The current business model of organisations in the inclusive finance sector is strong on operations and therefore manages operations related risks very well. However, in order to evolve into universal financial service providers, organisations need to focus on risk in a more holistic manner, ie look at all aspects of risk such as operational risk, credit risk, interest rate risk, liquidity risk, political and regulatory risk. Capacities need to be built internally, for instance, risk departments need to be set up, people need to be hired and adequate training needs to be provided, investment needs to be made in risk management systems. However, it was agreed that senior management buy-in was critical to the implementation of “holistic risk management”.

Participants comprise a select group of expert practitioners in the field of access to inclusive finance for low income households. The participants’ will engage and will help answer key questions of critical importance:

• How do we design a financial system in which there are multiple and diverse originators providing integrated financial services to low income households and small businesses, evaluating and pricing risks appropriately, and ultimately taking responsibility for good financial outcomes for their customers?
• How do we work towards understanding the needs of our customers for financial services better and fulfilling them?
• How do we design business models that are based on deep local knowledge and relationships, while ensuring systemic stability?
• How do we ensure that inclusive finance originators have adequate risk management capability and supporting infrastructure to ensure sustainability?
• How would the organization have to evolve to obtain efficient and reliable sources of funding?

The spirit of this meet is to take a step back from the existing products, institutional frameworks, and regulatory architectures, and take a more fundamental view of what can be done to improve the ability of our financial system to ensure access to finance for every individual and every enterprise.Together, we will work on a shared vision for the industry and identify specific pathways to achieve that vision.

Conference Website: http://capital.ifmr.co.in/partnersmeet/

Microfinance institutions (MFIs) essentially act as financial intermediaries, bridging the gap between mainstream financial institutions and low-income households for a specific type of credit need that is short-term and unsecured. The concept of risk lies at the heart of any such financial intermediation.

Systematic Risks

Systematic risks that face the entire sector, such as rainfall failure, impact the livelihoods of a large numbers of clients simultaneously and cannot be eliminated, but can be mitigated by purchasing insurance at a portfolio level, or diversifying across regions. However, a significant systematic risk that has emerged in recent times and which has impacted MFIs severely is political risk.

As MFIs deal with low-income households, their operations are subject to scrutiny by State governments and local powers, in addition to formal regulators. Recent experiences of political interference bring out the vulnerability of MFIs to these risks: In 2006, 50 branches of two major MFIs were closed by authorities in Krishna district of Andhra Pradesh; in 2009, repayments almost came to a grinding halt in Karnataka’s Kolar district; and in 2010, the Andhra Pradesh Government introduced a law that reduced MFI repayments dramatically.

Clarity on regulatory framework, and jurisdiction of State governments vis-à-vis non-bank financial institutions is critical in mitigating political risk. At the institutional level, this can be managed by building a closer connect between the institution and customer groups so that there is resistance to local political interference that constrains the business activities of MFIs.

Idiosyncratic Risks

Idiosyncratic risks are internal to an entity and comprise primarily operations and credit risk. In microfinance, these two are deeply intertwined and are potentially among the primary reasons why MFIs fail.

In the Joint Liability Group (JLG) model, typically followed by MFIs to disburse credit, as “credit decisions” are taken by the group on the basis of its access to private information about each member, the quality and robustness of the group formation process becomes crucial in credit risk management. The mechanism of group cross-guarantee, if implemented as per the rules that govern group formation, will result in positive selection of members. It is important, however, that the under-writing process be undertaken by the group and not by the MFI.

Dilution of group formation and meeting norms are early warning signs of process deterioration that should trigger concerns about credit quality. Outstanding MFIs pay a great deal of attention to factors such as length of the group formation process, regularity of group meetings and attendance rates.

Operational Risks

Microfinance is an operations-intensive model and weak processes affect internal control and manifest as fraud and other operational failures. Detailed mapping of the processes and sub-processes will help MFIs identify risks, as also the weak links that pose a greater threat of fraud. To detect fraud early and take action, MFIs should have a risk-scoring model, giving each branch a risk score. Taking a holistic view, the model should be based on diverse parameters. Branches with history of fraud should be penalised in the risk-scoring model and the frequency of audit linked to the risk score. This helps understand two key questions: Which branch has poor portfolio quality? Is the branch witnessing fraud?

Cash movement

As all MFI disbursements and collections are cash-based, the institutions face high risk due to movement of cash. This is exacerbated for institutions operating in remote geographies. If movement of cash is not tracked and checked against demand and collections, it can result in fraud.

Such fraud can be mitigated by MFIs setting cash retention limits for branches, with deviations approved and recorded. Reconciliation of cash through MIS in the branches’ bank accounts is important in scrutinising float and idle cash at each level. Risks such as burglary during cash movement can be mitigated through insurance for cash-in-transit; cash-in-safe and branch; and fidelity insurance.

Interest rate volatility

Interest rate volatility is among the key risks MFIs face today. Changes in interest rates at which they borrow impact spreads, especially in the short term. Most MFIs do not explicitly manage interest rate risk. Increase in cost of funds severely squeezes margins, impacting profitability and operational self-sufficiency.

With increased competition and pressure to cut interest rates, MFIs are also not in a position to pass on interest rate increases to clients. With proposed regulations on capping margins, interest rate risk will continue to be one of the key threats for MFIs.

Long-term borrowing, with hedging and diversification of funding sources, will enable MFIs to mitigate interest rate risk. Given that MFIs typically have positive duration of equity (liabilities are longer dated than assets), their asset-liability management strategies have also to take into account scenarios arising from interest rate movements that impact profitability.

As with any other financial institution, risk management is critical to the success of MFIs. The unique context of MFI operations that involve under-writing by client groups and dealing in large amounts of cash outside branch locations create specific risk management needs. MFI boards, lenders and investors should be cognisant of these features.

This article first appeared in The Hindu Business Line.

At the same time, many of the tactical and operational prescriptions made by the Committee require to be examined in the context of (a) broadening the RBI’s financial inclusion agenda, (b) regulatory approaches to pursuing this agenda (c) operationalising the recommendations in an effective and inclusive manner and (d) ensuring sustainable development and orderly growth of the industry by limiting externalities and developing a series of best practices.

Definition of the Sector

1. Under 2.1 of the Committee’s report, the Committee has defined microfinance as “an economic development tool whose objective is to assist the poor to work their way out of poverty. It covers a range of services which include, in addition to the provision of credit, many other services such as savings, insurance, money transfers, counselling, etc.”

2. At the same time, the Committee has confined itself to “micro-credit” for the purpose of the report.

3. The Committee has subsequently defined a separate category – NBFC-MFIs – for NBFCs operating in the microfinance sector, and stated that, in such firms, over 90% of assets must comprise of “qualifying assets”. At the same time, the Committee suggests that NBFCs should either allocate over 90% of assets to “qualifying assets” or less than 10%

4. We suggest that it is counter-productive to limit micro-credit or the supervision of micro-credit to NBFCs in the fashion as described above for the following reasons:

a) These recommendations, if accepted, would prevent the transformation of microfinance into full service finance for rural customers.

a. One of the main reasons for becoming an NBFC is that the entity is then able move beyond traditional JLG lending, and gradually start to offer larger loans, individual loans, enterprise loans, crop loans, equipment loans, etc. while continuing to offer the original JLG product.
b. This allows the entity to meet completely the requirements of those borrowers that need larger amounts as well as use the wider product-scope to spread its cost structures over a much larger pool of assets and bring its lending rates down, eventually well below even the caps specified by the Committee for the traditional JLG product.
c. Entities operating in this space would have to grapple with low value of transaction and still remain viable. Multiple sources of revenue would provide such viability to such entities.

b) The 90/10 recommendations (Clause Numbers 5.9 and 5.10), if accepted, would essentially freeze the sector to permanently stay in its current form since nobody else would even be allowed to address the needs of this sector and no other business models would evolve.

a. And for this reason, there would also then be no impetus for interest rates to come down further below the caps specified by the Committee. Costs of operations, using new technologies and economies of scope and scale can be brought down to as much lower levels relatively quickly.
b. This would also take away the entities’ incentive to invest effort in working in a challenging environment.

c) The recommendations would leave out significant microfinance providers from the regulatory framework

a. It is quite possible that Banks may emerge as substantial providers of micro-credit and other forms of microfinance, but microcredit (as defined by the committee) may not form 10% of their assets. This will leave out a significant institution-type from the regulatory ambit. The proposed regulation must cover all microfinance providers

i. However, it may be argued that microfinance, at present, is being provided by multiple non-profit entities that are not within the regulatory ambit of the RBI. Recognising this, we propose that microfinance regulation must cover at least all existing forms of entities regulated by the RBI, i.e. Banks and NBFCs
ii. The microfinance operations of such entities, be in micro-credit, micro-savings, distribution of micro-insurance etc., must be reported separately as an SBU to the RBI, to permit efficient information dissemination, transparency and effective regulation
iii. For entities outside RBI’s regulatory ambit, regulation could make the principals (in case of business correspondents) and lenders (in case of microcredit) to the providers aware of the importance adherence to client protection standards by the providers. These principals and lenders should be actively encouraged to broaden their due diligence and monitoring processes to ensure that the providers are not just maintaining financial discipline but also adhering to ethical standards of client protection.RBI must also actively use such measures to enforce covenants on entities not regulated by RBI to create a level playing field and uniform standards.

d) Further,

a. If entities were forced to concentrate over 90% of their assets in the microfinance sector, lack of diversification within their asset portfolios could emerge as a significant systemic risk.
b. In India, portfolio protection for institutions providing services to low income rural households against the vagaries of systemic and catastrophic losses, i.e. rainfall reduction, weather variations, crop losses, floods and other events etc. are still not available on a large scale

5. Hence, we recommend that the definition of microfinance be applied at a functional level, rather than at the entity level. This would imply that entities providing microfinance would be required to create separate business units, tailor internal policies to provide efficient service delivery and at the same time be able to leverage internal financial, technology and process strengths in this regard.

6. Ensuring complete access to finance for every individual and every enterprise in India will require continuous innovations in financial products, delivery channels, and human resource management by a wide array of strong firms competing with each other to do business with the low-income household in a responsible manner. By opening up the sector to multiple institutions will enhance competition and meet the regulator’s objectives

Capital adequacy requirement

7. The committee has not offered any rationale for the Rs. 15 crore minimum capital requirements even for pure non-deposit taking NBFCs despite recommending very conservative loan limits and being aware of the very low default rates that have been observed for this sector in India for over a decade.

8. Such a requirement clearly favours the established large microfinance providers, which making it even more difficult for smaller, locally focused entities to emerge.

The issue of “Qualifying Assets”

9. The Committee has defined a low income household as one with annual household income less than Rs 50,000

10. IFMR Trust’s experience is that though a large number of microfinance clients belong to households with less than Rs. 50,000 annual household income, there are also a very large number of households with higher incomes who can and do benefit from microfinance mechanisms.

a) This happens mainly because of limitations of the credit appraisal methods of traditional financial providers. Many rural and urban low income households cannot access credit through these mechanisms – their assets cannot be easily collateralised; their incomes are hard to estimate; and their past repayment records are not recorded in accessible databases.
b) So, though most poor are financially excluded, many financially excluded households have household incomes exceeding Rs 50,000. Much of urban microfinance caters to such clients. Restricting microfinance to the poor will make the financially excluded non-poor more vulnerable.

11. We believe that it would be detrimental to the interests of a large section of the population to define low income households in the manner as recommended by the Committee. Further, this definition implies that originators (and perhaps their lenders) have the wherewithal to collect information regarding household income, which is unlikely and expensive

12. The Committee has also stated that credit to individual clients be limited to Rs 25,000 per member

13. This is not clear and raises the following questions

a) What are such households to do when their credit needs outstrip Rs 25,000 per individual member?
b) Shouldn’t the committee focus on “regulating the lender” rather than “regulating the household’s debt needs”?
c) Is it not wasteful for such a household to approach multiple lenders, rather than avail of a single “one-stop shop” solution for financial needs?
d) Effect of inflation on household credit requirements are not factored in

14. Given the above negative effects on a household’s credit access, we find it difficult to believe this is the Committee’s intention. We suggest that it is up to the household to determine its own debt needs and requirements, and for the provider to determine the creditworthiness.

15. Given that the objective is to regulate the originators, we suggest the following approach

a) The Committee has opined that multiple loans given to a single household may increase the risk of non-repayment and amplifies systemic risk
b) At the same time, it is the objective of the committee to ensure that the maximum number of households come under the coverage of financial inclusion
c) Therefore, to incentivise organisations to enhance coverage and limit multiple lending to a single household it is proposed that a higher capital charge be levied upon institutions providing the third or further loan to a single household (at the time of providing the loan)

a. Therefore, the first loan to a household could attract a capital charge of 75%, the second loan 100%, the third loan 125% and so on
b. This could be tracked by stipulating the use of biometric authentication, and a credit bureau

16. It is useful to note that the group-based method (followed at present by MFIs as well as SHGs) ensures that each borrower is forced to assess his / her co-borrowers before forming a group. The ability of this methodology to impose credit discipline is well-documented. Even during the current crisis, IFMR Trust has monitored repayment behaviour in over 200 districts across the country outside Andhra Pradesh, where repayment behaviour has been flawless1

Our experience tells us that, contrary to popular belief, low income households are rational and well able to take complex financial decisions. Rather, such households are limited by the quality and depth of the financial instruments that they have access to. This evidence is bolstered by the book “Portfolios of the Poor” and a recent impact study2 conducted in Hyderabad by MIT researchers.

17. The committee seems to be taking a view that it not only needs to regulate the lenders, but also the households’ financial lives. It should focus on regulating the lenders and developing ways to indirectly reduce the risks of over-leveraging and systemic risks. Therefore, credit discipline on lenders through usage of capital charge, is a better risk management tool that will also form an effective check on over-lending, rather than imposing an external limit on the borrowing ability of households.

18. Further, it is incorrect to assume that rural households have no collateral at all to provide for raising debt. Banks are known to have substantial exposure to the agricultural sector that is collateralised through land holdings, household gold and farm equipment

a) We had earlier made the argument favouring using microfinance providers for delivery of multiple services for efficient service delivery at lower cost
b) Though much of microfinance has focused on credit, it should include other services as well. IFMR Trust’s experience with remote rural households across three states (Tamil Nadu, Uttarakhand and Orissa) shows the benefits clients can get from such complete offering, and how such a multi-service approach helps the institutions improve efficiency by leveraging economies of scope, which can be tapped in the context of financial services.
c) Therefore, we submit that organisations should be permitted to offer a complete suite of financial services to low income households viz.

a. Loans – both secured and unsecured. Secured loans that require a high penetration of distribution include crop loans, loans against warehouse receipt, MSME loans etc.
b. Distribution of savings, either through Banks or through mutual funds
c. Distribution of insurance – life, cattle, weather, crop, accident, health etc.
d. Remittances

d) It is necessary that such organisations develop the breadth of knowledge and understanding that is necessary to understand low income household needs and prevent mis-selling. This is something that can be periodically audited by the RBI

Pricing of Loans

19. The Committee feels that “Given the vulnerable nature of the borrowers, it becomes necessary to impose some form of interest rate control to prevent exploitation”

20. Evidence from other countries however shows that pricing caps have historically hurt the poor3 . Pricing caps and margin caps incentivise originators to expand only to easily serviceable geographies and ignore remote areas and lower income clients.

21. Further, the sharp increase in financing costs for MFIs post the AP Ordinance has indicated that originators are not insulated in any manner from high borrowing costs during either (i) a liquidity crunch or (ii) a credit situation / event risk

22. IFMR Trust has, on several occasions, opined that the current interest rates and margins charged by MFIs are high and there is room for reduction. However, at the same time, we believe that competition and transparency should pave the way for reduction of rates rather than impose a hard cap. This is indeed the view RBI has taken on pricing of services offered by banks through business correspondents, allowing banks to decide the price they want to charge, but requiring them to have the pricing approved by the boards, and transparently communicate it to RBI and other stakeholders.

23. Suggestions to this effect include enhancing competition, imposing transparency in pricing (already recommended by the Committee) and monitoring the originators by tracking reduction in interest rates over a period of time

a) Further, originators could be encouraged to augment lending revenues through fee based income achieved through distribution of specially tailored products for low income households, e.g. livestock insurance, low ticket savings and remittances. This would permit originators to reduce costs on lending products
b) Originators that provide other forms of secured products, together with unsecured loans, could also avail of cheaper funding from lenders that could be used to reduce lending rates for the unsecured loans

Purpose / end use of the Loan

24. The Committee believes that microfinance should largely focus on income generating purposes, and has opined that a minimum of 75% of microfinance loans should be for “income generating purposes”

25. This topic needs to be examined from three aspects:

a) What exactly is an “income generating loan”?
b) What are the current purposes for which borrowers are using loans?
c) Loans used for functions that other services usually fulfil

26. What exactly is an income generating loan? Evidence shows that loans are used by low income households for a variety of purposes including:

It is difficult to opine that households should be restricted from using external financing for any of the above activities, especially when the middle-class and the rich are permitted to borrow for all of the above purposes and have access to funds as well

27. It is clear from studies that low income households have utilised MFI loans for a variety of purposes. Recent evaluation of an MFI’s urban microcredit programme in Hyderabad revealed a variety of uses for the loans:

While such percentages vary widely across households, it is clear that each household is faced with a specific set of economic, social and risk variables that require a certain course of action. It is counterproductive to impute (or impose) a specific end-use pattern to a household.

28. Loans used for functions that other services usually fulfil: Since most of these households may not have a savings facility, they might be using a short-term loan to “save-down”, instead of “saving-up” as one does using a savings bank account. Some researchers have also posited that microfinance helps because it acts as a disciplining device for people to save, and they can use the discipline of weekly repayments to help bind themselves into putting money aside, which they otherwise would not have been able to do5 . Transformation of small amounts into lump sums is an important function for households6 , and in the absence of other mechanisms (like savings account, recurring deposits), microfinance serves as a mechanism to help make this transformation. These other purposes (consumption smoothing by transforming small amounts of money into lump sum; reducing cash outflows by repaying expensive old debts; etc) can be and often are welfare enhancing

29. Traditionally the low income household is only familiar with credit as a tool for financial needs and have developed coping mechanisms based on access to credit. While other financial products would clearly be useful to such households, they would need time to adapt to such tools.

30. While financing for certain end-use could be encouraged (i.e. through the priority sector guidelines), it is counter-productive to impose end-use restrictions on households when no such restrictions exist on higher income households. It is conceivable that, through disincentives on multiple-lending, originators would take greater care in ascertaining the repayment capability of the household, as well as diversify into products that would be directly linked to business activities, e.g. retailer loans, crop loans, small business loans etc.

31. The view the Committee eventually takes on the manner in which poor women conduct their financial lives and their maturity and sagacity is deeply disturbing. Microfinance plays multiple roles in the lives of low income households including seasonal cash management (so that school fees can be paid even during the seasonal troughs); asset transformation from small savings to larger valued assets (such as higher quality roofs and beds); refinance of high cost loans from money lenders; and as a substitute for good commitment-savings products. This is also acknowledged by the Committee but while making its recommendations it surprisingly reaches an opposite conclusion without citing any research or offering any rationale for overlooking its own earlier observations or suggesting any alternative solutions.

32. These recommendations of the Committee along with those restricting the amounts she can borrow and severely limiting the choice of providers that she can access, constitute an infringement of the rights of the low income household, particularly women, to conduct their own financial affairs as they think best fit. Similar stipulations, if imposed on middle and upper income households would be resisted very strongly, but have been recommended for imposition on poor women without any evidence that they are in any way less rational than high and middle income customers and good evidence that the opposite is actually the case.

Incentives for Orderly Growth

33. The Committee has recommended the creation of a Credit Bureau for ensuring orderly sharing of information. We wholeheartedly support this initiative and believe that fully functional (and competing) credit bureaus are essential for the orderly development of the sector

34. Further, and very critically, the Committee has suggested that a single regulator is necessary and sufficient to monitor microfinance activities. This is extremely important, especially in the context of the AP Ordinance, and will go a long way towards dispelling uncertainty on the legal and regulatory environment

35. We also have a few other suggestions regarding the role that the RBI can play in facilitating orderly growth. These include:

a) Ensuring incentive alignment of stakeholders to enable market-based regulation –

a. Use of the priority sector guidelines
b. Securitisation

b) Ensuring continuity of service
c) Promoting healthy competition amongst originators

36. Incentive alignment

a) The priority sector guidelines can be used very effectively by the RBI in controlling and at the same time incentivising originators and lenders to behave responsibly. The Committee has recommended continuation of priority sector for microfinance advances and we are in support

Some additional steps that could be brought in the priority sector guidelines:

a. Unsecured loans provided to a household could attract a higher priority sector weightage than secured loans (the RBI has already moved a step in this direction by stating that gold loans made for agricultural purposes may no longer be treated as direct or indirect agricultural advances)
b. First and second unsecured loans given to a household could have a higher weightage than subsequent loans – tracked through a credit bureau

b) Securitisation and other capital market transactions: traditionally, originators of financial services to low income households have been far too dependent on bank borrowings (the Committee estimates that 75% of loans to MFIs are from banks)

IFMR Trust has been working closely with high quality originators to assist them in availing capital market financing through securitisations and bond issuances. We strongly feel that the additional transparency imposed by a capital market transaction is very beneficial in incentivising originators to “raise the bar” in MIS, reporting, operational processes and systems, so as to be able to meet the scrutiny of rating agencies and investors

37. Continuity of service: Continuity of service delivery should be seen from the perspective of “who is taking risk on whom”, because based on this the importance of and strategy for ensuring continuity of service delivery will be determined.

Clients taking risk on the institution (Savings, Insurance, Investment, Remittance): For services like savings and insurance, there is a strong case for high level of prudential regulation to prevent failure of institutions, because of the need to protect clients’ savings and insurance. For these services, the regulation should continue on the path of letting prudentially regulated, well-capitalised, well-diversified institutions provide microfinance through agent-led models, like the business correspondent model. To ensure continuity of these services, the continuity of both the principal and the agents is necessary.

The principal institutions (banks, insurance companies, asset management companies, etc) are already governed by detailed prudential norms, which are meant to minimise the risk of failure. For such agent-led models, the regulator should make the principal financial institution (eg. banks appointing the business correspondent) responsible for ensuring continuity of service delivery to the clients, with penalties if an acquired client is not able to access the service continuously for a certain period of time. These principal institutions should then draft their own due diligence and monitoring criteria to ensure this.

At the same time, the model should ensure that every originator (who serves as an agent) has sufficient risk participation to prevent the risk of moral hazard.

Institution taking risk on the clients (Loans): Considering the fact that most of the microfinance providers (except banks) in India do not mobilise public deposits, we believe that the RBI need not take further steps towards regulating such institutions except defining basic prudential norms on institutions that are non-systemically important.

However, we strongly believe that the RBI should focus on ensuring that a microfinance originator’s practices do not have negative externalities for other originators. IFMR Trust’s experience is that maintaining high quality field processes is a must for microfinance. Hence, regulation that is focused on reducing negative externalities will be immensely useful. Some suggestions:

a) Develop an external audit mechanism through third parties: Such third parties auditors could (i) verify through sample checks the quality of origination and reported profiles of customers, (ii) define process standards for processes in origination, collection, risk management etc7 and audit the same, (iii) provide feedback to the institution on their findings, (iv) provide inputs to the lenders of such originators

b) Use differentiated capital charge, as outlined earlier, to prevent multiple lending

Client Protection

38. The Committee has recommended certain steps with regard to client protection including

a) Prevention of coercive collection practices
b) Customer protection code
c) Transparent pricing

39. We are in agreement with the broad line of thinking and offer a few suggestions regarding the same

a) While it is fair to state that borrowers of group-based lending are not to be visited for non repayment at their residence, the same is not true for borrowers of individual loans / business loans / crop loans etc. The RBI should make a distinction between loans where group liability serves as a cushion against individual default, and individual unsecured loans

b) Where security is available to the originator (property, gold, movable assets), the originator should have clearly defined, board-approved, policies regarding any appropriation, auction and disposal of such assets. Such policies must follow the Fair Practices Code and every such incident of recovery from security must be monitored at the highest level in the originator’s organisation

c) IFMR Trust’s stringent underwriting guidelines stipulate that no originator should use the services of or incentivise third parties to originate and service the loan clients. While it has been observed that originators use group leaders or center leaders for such purposes, this must be completely stopped

d) Transparent pricing to clients must be enforced, displayed in loan agreements, explained during customer interactions etc. The RBI could consider prescribing standard communication components which cover various methods of calculation of interest (Upfront fees, flat rate, reducing balances rate etc.) and also various repayment cycles (Equated, ballooning, variable) to bring them to ‘effective cost to client’ numbers so that clients can make informed decisions

e) Prevent mis-selling: Regulation should prescribe fair origination practices by microfinance providers. Some activities that should be actively discouraged are: compulsory bundling of products, miscommunication about product features and giving wrong advice to clients. Explicit confirmation from the clients that such practices have not been indulged in should be obtained by external process auditors to create pressure towards adherence

f) Mechanism for redressal of grievances: All originators must be required to have in place timely and responsive mechanisms for complaints and problem resolution for their clients. This requires ensuring that clients are able to contact a person who can then address their grievances effectively and in a time-bound manner. Apart from this the regulator must make available mechanisms outside of the institutional framework to address unresolved queries or queries of larger magnitude. The banking ombudsmen with enhanced capacity would be best placed to perform this function without conflict of interest

g) Privacy of client data: The privacy of individual client data must be respected in accordance with the existing laws and regulations, and such data cannot be used for other purposes without the permission of the client. Explicit regulations around when and how information sharing is possible should be notified. Severe implications must be notified to ensure that originators do not overstep on this requirement

IFMR Trust believes, and has learnt through experience, that small, local financial institutions are best placed to understand the financial needs of low income households and deliver financial services to their doorstep. It is critical to avoid a situation where regulation favours large players over smaller ones. Several provisions of the Committee’s report that may have this unintended consequence are:

➢    Interest rate/Margin cap
➢    Allowing only 2 lenders per household
➢    Minimum networth

These recommendations favour the largest existing originators, are likely to drive smaller MFIs out of businesses, and create entry barriers for any new players. The larger originators benefit from economies of scale and will be more easily able to comply with the increased capital requirements.  They will be more easily able to build the infrastructure recommended and move faster into the market place where they could corner the maximum market share thereby preventing the entry of smaller or newer MFIs in that market.

We strongly feel that such measures will be detrimental to the financially excluded and will not serve the RBI’s motive of financial inclusion. Permitting only larger originators to flourish will imply an oligopolistic situation, lesser product innovation, poor customer service and ultimately choking the household’s credit requirements.

We believe that there is an important role for the regulator to play in making sure that innovation is encouraged among responsible players in a manner that benefits low income households, and we are hopeful that the RBI will agree with our view when it reviews the Malegam Committee’s report.

—

(1) This observation is based on (a) over twenty field visits conducted in states outside AP, post the AP Ordinance, (b) data from securitized pools in over 200 districts, (c) behavior of borrowers of IFMR Trust’s own retail financial services venture in remote rural areas of Tamil Nadu, Uttarakhand and Orissa
(2) The paper titled “Miracle of microfinance? Evidence from a randomised evaluation” can be found here: http://econ-www.mit.edu/files/4162
(3) CGAP Occasional Paper No. 9. http://www.cgap.org/gm/document-1.9.2703/OP9.pdf
(4)These percentages don’t add up to 100 because some loans were used for multiple purposes.
(5)http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1598959
(6)See page 17 of http://www.portfoliosofthepoor.com/pdf/Chapter1.pdf
(7)IFMR Trust has developed detailed underwriting guidelines for such providers of financial services, including detailed process and system guidelines that such an institution must follow

[The author is an independent columnist. This article is a reproduction of his column from The Telegraph]

The Reserve Bank of India is an exceptionally clean and efficient organization. It discourages contact between its staff and outsiders in the belief that personal contacts are an essential component of corruption. That could make it unfriendly to outsiders. But it promises quick response to letters, and almost invariably gives it. It minimizes discretion by making clear rules. Its rulebook runs into thousands of pages; but the result is that everyone knows or can find out rules, and everyone gets equal treatment. In brief, the RBI is an admirable institution; if the Central and state governments ran half as well as it, Indian lives would be much improved.

But, as can happen with rule-bound institutions, it is extremely compartmentalized; it does not see the interconnections between the various areas it oversees. And it has strong preconceptions. In particular, it dogmatically protects the interests of banks, and of government banks in particular, and is consequently biased against change and innovation. How much damage this blinkered approach can do is illustrated by the report prepared for its directors by a sub-committee to study issues and concerns in the microfinancial institutions sector.

To begin with, the committee’s terms of reference were so narrowly defined that it considered only MFIs and defined them as only lending institutions; it consequently ignores the larger purpose, which is to extend financial services to the villages and the poor. Contrast this with the Raghuram Rajan Committee of the Planning Commission, which is never mentioned by the RBI. It said that the poor have three kinds of financial needs: credit, security, and earning from savings.

It would save costs if the needs were fulfilled by the same institutions; for that, financial institutions need to be diversified. The RBI’s model of the institutions as extensions of banks is ill-suited to the needs. There is plenty of evidence of its weakness, for example cooperative credit societies and rural banks.

The Rajan Committee pointed out that microfinance organizations needed to raise money from somewhere. The answer was obvious to the MFI committee: the money would come from the banks. But there is an even more obvious answer that it strenuously avoided: the money can come from their clients. In other words, the MFIs would be much more viable if they could take deposits — if they were banks themselves. And the need is not for a dozen or two; to reach 700 million people in half a million villages, thousands of banks would be needed. The RBI hates this idea, and relates how experiments with small and rural banks have failed. If banks are to be made failure-proof, they must start with huge capital; the RBI would not think of anything less than Rs 300 crore. They would have to have promoters with deep pockets; and since there are not so many of them around, only a handful of new bank licences can be given.

But if the Rajan Committee is right, the fault did not lie with their smallness. Cooperatives failed because they were used only to channel credit from state governments; they came under the control of local politicians who gave themselves loans and forgot to repay. This was, for example, the story of the Maharashtra sugar cooperatives, but it will never be mentioned in any official document because the politicians who ruined the cooperatives were the pillars of the Congress. The record of state-sponsored credit institutions is at least as bad as that of private ones.

The MFI committee wants the MFIs to confine themselves to lending to the deserving poor, and wants to place a ceiling on the interest rates they charge. Both proposals are designed to make MFIs less profitable and therefore more susceptible to failure. Interest rates charged by moneylenders go to very high levels. That is what creates a business opportunity for MFIs. They can charge high rates and still lend more cheaply than moneylenders. But the rates are not high just because moneylenders are crooks and exploit their borrowers. Costs of giving small loans to a large number of borrowers in villages are high; so are the risks. They will affect MFIs as much as they do moneylenders, and MFIs will have to charge high rates if they are to survive and to put something by for expansion. Hence it is a thoroughly bad idea to control their interest rates, or their margins — and it is impossible to control both together, as the committee’s chairman, Yezdi Malegam, a chartered accountant, should know.

More generally, the MFI committee wants to confine MFIs to lending to the deserving poor, and for that purpose, to collect considerable information about their income, their borrowings and so on. One wonders which world the committee is living in. A villager may do some agricultural labour while it is available. She may go and work on some public works if any are going on. She may go to the next town and do some domestic work. The poor find work wherever they can, and travel for it. The MFI committee wants MFIs to pursue the poor and compile a record of how much they are earning, how much they have borrowed and from whom, and so on. It expects the itinerant poor to cooperate with the MFIs and give them all the information from day to day. This is unrealistic; if MFIs keep collecting such detailed information, they will be able to lend to very few.

But then, the MFI committee does not expect them to lend to the poor. It wants every poor person to join a “self-help group”, borrow through it, and repay through it. It wants the MFI to sit in the courtyard of the village council and wait for SHGs to come and transact business; it would prohibit anyone from an MFI to ever go near an individual’s home. It has a closely defined, structured model in view: banks would finance a very small number of MFIs, MFIs would deal only with SHGs, and all SHGs would be attached to and sponsored by the establishment of the village. This would be very convenient for the RBI; it would simply reproduce its current model of bank regulation and extend it to villages.

It seems to me that the Malegam report has been designed to enable the RBI to keep close control of rural credit and to keep its hands clean. It is simply not concerned with creating competition, bringing down the costs of financial services, or taking to villages the variety of financial services that townsmen are used to or with encouraging innovation. As I have said, I have a high opinion of the RBI’s competence. I also think that the government has created too many financial regulators, chiefly to create jobs for its favourite bureaucrats, and that we could do with fewer. But it could not make a bigger mistake than allow the RBI to regulate MFIs; that would be the way to deal rural financial development a death blow. In fact, the RBI’s recent attitudes make me wonder if it has lost the plot. Maybe it should rethink its entire model of regulation.

We are less enthusiastic that the Malegam Committee chose to focus their efforts narrowly on the product design of the JLG loan instead of understanding the way microfinance functions and proposing the proper role of market players in ensuring orderly growth of this sector.

Ensuring complete access to finance for every individual and every enterprise in India will require a flurry of innovations in financial products, delivery channels, and human resource management by a wide array of strong firms competing with each other to do business with the low- income household in a responsible manner.

Efforts to stifle this innovation by the Malegam Committee – no matter how well intentioned – must be reconsidered.

We believe that there is an important role for the regulator to play in making sure that innovation is encouraged among responsible players in a manner that benefits low income households, and we are hopeful that the RBI will agree with our view when it reviews the Malegam Committee’s report.

Although we appreciate the positive intention of the Malegam Committee, the report that it issued has numerous sections that will undoubtedly (1) hurt low-income households, (2) protect the largest incumbent MFIs, and that (3) perpetuate the convenient myth that low income households are more irrational than the rest of us.

The following is our perspective with respect to several sections of the report that we believe require additional consideration.

Recommendations that will hurt low income households

Recommendations that will protect the big incumbent MFIs

Many of the recommendations favour the largest existing MFIs, are likely to drive smaller MFIs out of businesses, and create entry barriers for any new players.

The larger MFIs benefit from economies of scale and will be more easily able to comply with the increased capital requirements.  They will be more easily able to build the infrastructure recommended and move faster into the market place where they could corner the maximum market share thereby preventing the entry of smaller or newer MFIs in that market.

Recommendations that improperly assume that low income households are more irrational than the rest of us

The Sub-Committee has recommended creation of a separate category of NBFCs operating in the microfinance sector to be designated as NBFC-MFIs. To qualify as a NBFC-MFI, the Sub-Committee has stated that the NBFC should be “a company which provides financial services pre-dominantly to low-income borrowers, with loans of small amounts, for short-terms, on unsecured basis, mainly for income-generating activities, with repayment schedules which are more frequent than those normally stipulated by commercial banks” and which further satisfies the regulations specified in that behalf.

The Sub-Committee has also recommended some additional qualifications for NBFC to be classified as NBFC-MFI. These are:

1. The NBFC-MFI will hold not less than 90% of its total assets (other than cash and bank balances and money market instruments) in the form of qualifying assets.
2. There are limits of an annual family income of Rs.50,000 and an individual ceiling on loans to a  single borrower of Rs.25,000
3. Not less than 75% of the loans given by the MFI should be for income-generating purposes.
4. There is a restriction on the other services to be provided by the MFI which has to be in accordance with the type of service and the maximum percentage of total income as may be prescribed.

The Sub-Committee has recommended that bank lending to NBFCs which qualify as NBFC-MFIs will be entitled to “priority lending” status. With regard to the interest chargeable to the borrower, the Sub-Committee has recommended an average “margin cap” of 10 per cent for MFIs having a loan portfolio of Rs. 100 crore and of 12 per cent for smaller MFIs and a cap of 24% for interest on individual loans. It has also proposed that, in the interest of transparency, an MFI can levy only three charges, namely, (a) processing fee (b) interest and (c) insurance charge.

The Sub-committee has made a number of recommendations to mitigate the problems of multiple-lending, over borrowing, ghost borrowers and coercive methods of recovery. These include :

1. A borrower can be a member of only one Self-Help Group (SHG) or a  Joint Liability Group (JLG)
2. Not more than two MFIs can lend to a single borrower
3. There should be a minimum period of moratorium between the disbursement of loan and the commencement of recovery
4. The tenure of the loan must vary with its amount
5. A Credit Information Bureau has to be established
6. The primary responsibility for avoidance of coercive methods of recovery must lie with the MFI and its management
7. The Reserve Bank must prepare a draft Customer Protection Code to be adopted by all MFIs
8. There must be grievance redressal procedures and establishment of ombudsmen
9. All MFIs must observe a specified Code of Corporate Governance

For monitoring compliance with regulations, the Sub-Committee has proposed a four-pillar approach with the responsibility being shared by (a) MFI (b) industry associations (c) banks and (d) the Reserve Bank.

While reviewing the proposed Micro Finance (Development and Regulation) Bill 2010, the Sub- Committee has recommended that entities governed by the proposed Act should not be allowed to do business of providing thrift services. It has also suggested that NBFC-MFIs should be exempted from the State Money Lending Acts and also that if the recommendations of the Sub-Committee are accepted, the need for the Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Act will not survive.

The Sub-Committee has cautioned that while recognising the need to protect borrowers, it is also necessary to recognise that if the recovery culture is adversely affected and the free flow of funds in the system interrupted, the ultimate sufferers will be the borrowers themselves as the flow of fresh funds to the microfinance sector will inevitably be reduced.

Background

It may be recalled that the Reserve Bank of India in October 2010 set up a Sub-Committee of its Central Board of Directors to study the issues and concerns in microfinance sector, under the Chairmanship of   Shri Y H Malegam, a senior member on the Reserve Bank’s Central Board of Directors. Other members of the Sub-Committee included Shri Kumar Mangalam Birla, Dr. K C Chakrabarty, Deputy Governor, Smt. Shashi Rajagopalan and Prof. U R Rao. Shri V K Sharma, Executive Director, Reserve Bank of India was the Member Secretary to the Sub-Committee.

Download the complete report here.

We have maintained a consistent position that despite all the imperfections of the MFI industry, the AP crisis was brought on primarily by the Ordinance that restricted the ability of MFIs to collect on the loans they had made and the misplaced perception of key stakeholders that this is an unregulated industry, despite 80% of the loans being made by RBI regulated NBFCs. It was (and still is) imperative to remain completely focussed on solving the immediate issues of liquidity and prevention of contagion to other states so that the collateral damage to hundreds of genuine initiatives is minimised and that the lifeline of access for customers is not permanently damaged.

However, now that the RBI has made a call to restore liquidity, we hope that the short-term issues will be managed and it is time to turn our attention to some of the deeper messages from the crisis. We are proposing a 5 point action plan for MFIs to ensure that there is a better acknowledgement of the value of their contributions to the life of a low-income household the next time around:

1. MFIs provide a very useful service to clients by allowing them to manage their cash intra-year between periods of excess income and deficit income. This kind of cash management ability makes a big difference to a low-income household by reducing their need to sell household assets or take on expensive informal loans. In addition to this service however, MFIs must increasingly work hard to build a relationship with the communities that they serve. They must track the financial well-being of every household that they serve. They must hold themselves and their loan officers accountable to this metric. This is imperative if the community has to stand by their side in future crises.

2. Voluntarily and unilaterally cut interest rates to not exceed 8% above cost of bank loans. Our research suggests that this is very much within reach of the efficient entities who have crossed a minimum scale. If for some MFIs operating in remote geographies, operating costs do not justify the 8% benchmark, they must provide clients with instruments that will let them benefit from future profitability for the “equity capital” that they have inadvertently provided to the entity in its early stages via higher interest rates. The experience of Shri Renuka Sugars in making farmers shareholders may be instructive here.

3. MFIs must remember that the only collateral they have in the traditional Grameen-style loans is group cohesion. Collection problems inevitably can be traced to problems in the way loans are originated. MFIs must remain committed to process adherence. Reinforce to the group before disbursing a loan the nature of their responsibility and re-confirm that there is sufficient knowledge and willingness to guarantee, given multiple loans that some group members may already have. This might require some modifications to the traditional way in which Group Recognition Tests (GRT) are performed. MFIs must invest in training their field staff to deal with delinquencies in a mature manner. Have board approved processes for delinquency management that are then routinely audited by your Internal Audit Departments.

4. As the current loan portfolio runs off over the next twelve months MFIs must consider booking new loans into smaller, regionally focussed and well capitalised subsidiaries rather than into the national entity. This will be great for leadership development, better community engagement as well as converting non-diversifiable systematic risk into much more addressable idiosyncratic risk. Convert the national entity into a holding company [http://bit.ly/dH6VKY] purely for the purposes of raising equity capital and holding all the process and technology capabilities.

5. Ultimately however, the real power of financial services to the low-income household can be realised only with a far more comprehensive approach. When MFIs think about their evolution over the next decade, they might want to think about transforming the business model and channel architecture to enable provision of a broader suite of financial services to clients in a way that is customised to meet every client’s requirement; some appropriate combination of savings, loans, insurance and pension.

What does it mean to be a farmer in Kurnool (a district in Andhra Pradesh)? One part of the district grows commercial crops such as sunflower and tobacco while another supports nothing but paddy (the Telugu-Ganga Canal influences the soil in way that only paddy can be grown here). Against this backdrop, we wanted to understand the lives of the farmers in the district, what they do for sustenance and how they manage their finances. We travelled across Kurnool and met a diverse cross- section of respondents covering small and large farmers, housewives, small businessmen, Sarpanch and SHG presidents. As a part of our conversations with these respondents, we enquired with them about formal and informal sources of finance available to them, especially through microfinance institutions (MFIs) and their experiences with them. These were in-depth interviews with individuals as well as with groups as other villagers often gathered around us to share their views as well. We also met an officer from a government owned bank to understand his view of the financial options available to his clients.

Following qualitative research methods, we aimed to maximise diversity in our respondent set. The purpose of this post is neither to generalise our findings nor to draw conclusions merely based on our observations from this trip, but to place on record the multiplicity of voices heard from the field on issues at the heart of the microfinance debate. We feel that many of these perspectives and personalised narratives have been missing from recent coverage on the Andhra Pradesh microfinance situation.

[The names of the respondents have been changed at their request to protect their privacy.]

Weather shocks

The farmers of Kurnool district are reeling under the damaging impact of fungal attacks on their crops. Vast expanses of black paddy fields greeted us as the two of us travelled to Nandyal in the Kurnool district of Andhra Pradesh. 

An excess of rainfall  and prolonged wet weather has led to fungal attacks on almost all the paddy fields in the region. (By November 24, 2010, 496,000 hectares have been submerged or otherwise damaged due to the excess rains and yields are expected to be much lower than usual.) These are difficult times for farmers who had toiled hard all through the sowing season, often borrowing to meet their daily expenses in the hope of a good harvest. But their crops are being attacked by a disease that would reduce their yields to less than 50% of normal yields. The question in our minds, as we observed this was, how does a farmer here manage her financial requirements?

Fungal attacks on the paddy fields in the region

“[This year] I planted sunflower and turmeric along with paddy. These commercial crops require high levels of investment. [To make these investments] I rely upon my savings, bank loans against the collateral of my land and on the rental that the small farmers pay for leasing parts of my land”, says Abilash, a farmer with 10 acres of land in Atmakur village.

We ask him what role a microfinance institution (MFI) plays here.

“Only about 10 percent of my investment cost is met by the MFI loan” he replies. “But you should talk to my labourers or the small farmers from the lower caste / tribal colony. They are the ones that keep taking MFI loans”, he adds.

While talking to them we learnt that the “colony” people are the ones who are hired as labourers by the big farmers or lease a piece of land from them. If they choose to lease the land, they have to pay their lease rental upfront because the landlords do not want to bear the risk of crop failure (the big farmers also confirmed the existence of this practice). Since they are from a “lower caste” they do not even consider requesting permission to pay at the end of the harvesting season. They also know that if they take loans from these rich farmers and default, they run the risk of being boycotted by the entire village.

No land documents meant that the lessees had no access to a source of financing such as a commercial bank. Moneylenders or MFIs were the only options left for them to approach. (Self-Help Groups interestingly, had not yet caught their attention, though they are aware of it).   “The moneylender does not give us the amount of loan we want. Not because we are not capable of repaying, but because he wants to have us hooked to him. He gives about half of what we need tells us that only if we repay this promptly will he give us more. God knows how much interest I have paid him!” says Ahmed, a “colony” resident who has taken one acre of land on lease.

This means there is still some more money that needs to be borrowed. “We have BASIX, SHARE and Swayam Krishi [SKS] operating here and they have been good to us. My wife took the loan and I was able to take the land on lease, buy some pesticides and fertilisers. Last year, we had a bountiful harvest so I decided to lease more land and cultivate more cash crops. But this year the crops have failed and I have spent all the money I took as loans.”

So what would he do to repay the moneylender and the MFI? “For the microfinance loan, my wife works as a daily-wage labourer and she earns enough to repay the Rs. 250 weekly repayment. But I don’t know what to do with the moneylender. I will have to borrow more from him or someone else to repay his loan” he says.

By now, we are surrounded by some 20 people, all from the “colony” and all of them (excepting 2) had taken loans from MFIs. We asked them if they had ever faced any difficulties in repaying the MFI loans. “Sometimes we do face difficulty”, one of them said. “I have a small piece of land and my wife works as a daily wage labourer. Sometimes, when my wife falls sick, we lose income for a few days. Then weekly repayment becomes difficult. If it was a monthly repayment, we could easily compensate for it by working extra. The recent system of paying monthly has helped us.”

Multiple borrowings

We raise the issue of adequate borrowings and we ask if they have multiple borrowings and why. An elderly farmer in the crowd says, “We told you before that our requirements are never met completely from one source. Why would we borrow from different people if there was no need to do so?”

A labourer who had never taken an MFI loan interjected, “Do they explain why they take your signature while giving the loan? They have the capability to auction all your property if you don’t repay them on time”. When we ask him if he had read any such document from an MFI, he said he had only heard people say it. We ask them if the MFI had explained the documents and procedure. The others said, “They did, but we did not understand and we were all eager to take the loan.”

When we meet a group of women in a different mandal (Allagadda) the next day, we get some more perspective on the phenomenon of multiple borrowings. The women said they do have multiple borrowings, often up to four MFI loans. A woman who sells sarees for a living says, “I know my neighbour goes for Monday, Tuesday, Wednesday and Thursday groups. I too have taken loans from three MFIs”, says one woman. But why did they take these loans? “Why should we say no when someone gives it to us? We get good income and we know we can pay off the weekly dues easily. Then what is wrong in taking the loans?” she replies.

One of the women says, “When a new MFI enters our village, they first enrol the women who already have an MFI loan. They call us and explain that they are a similar company and that they would offer higher loans. Next, they ask us to bring our friends and they continue to offer loans. We keep taking loans from them because we have a need. Besides, who are they to decide how much I can afford? I know my limitations and I will take as long as I have a need. If I don’t tell them, how will they know if I have already taken a loan [from elsewhere]?” another woman asks. “Even if the MFIs checks on who is borrowing [from multiple sources], we will produce five new faces and as soon as MFI gives them the loan, we take the money from them” said another woman, while others laughed and agreed with her.

Collection practices

The previous day, when we were in the “colony”, we had asked the small farmers and labourers what the loan officer would do if they failed to repay. “They would insist that we repay. They would sit here and ask us to clear our dues. Normally, if my friend has a genuine problem such as illness of a child, we would pool in money and cover her. Didn’t we agree to do it when we took the loan?” they said.

The women in Allagadda also give us a similar answer. “They come here exactly on the same day and collect the amounts from the centres. We believe them because they are very professional. They do not even drink water or even talk to us anywhere else other than at the centres”, says one of the women.

We ask them what would be the officer’s response if they did not pay. “Why would I not pay? Had I not agreed to pay every week when I took the loan? If I do not pay, my group members lend me money for the week. I put in extra work and repay it to them” is the reply. There was strong sense of conviction in their voices.  In case of a second default, the woman can still depend on the group to help her again, but not the third time. “The third time is when things become bad”, they say. “Why would I help someone who is not interested in repaying her own loan?”

“How would the loan officer behave then?” we ask.

“He would say that the group can leave the centre only after paying the instalment and I would not blame him for that. But why would I have to sit unnecessarily if it is not my fault? I would shout at the woman [defaulter] for being careless. Anybody, who has borrowed has to pay up.  Am I not paying my dues?” replies one of the women.

Interest rates

In all the conversations that we had, the most striking aspect was the absence any mention of high interest rates. In fact, the Sarpanch of a village acknowledged that because of the presence of MFIs, the money lenders had brought down their interest rates.”If the MFIs were not there, the money lenders would create an artificial scarcity and would say that loans were available only at 5 percent per month. Now it is available to us at 2-3% per month”.

When we met the branch manager of a government owned bank in the village and asked him about other sources of finance for the villagers, he said there were about 300 SHGs in his branch and he was all praise for them. “We insist that all the team members to come to the bank when they want to withdraw money”. On the Joint Liability Group (JLG) model used by the MFIs, he said would really be interested in testing out the JLG model. “But unfortunately, I am short-staffed and am not able to spend as much time on forming these groups and managing weekly payments”, he said.

Farmer suicides

Almost all the respondents we met had heard of farmer suicides. When we asked them how they felt about deaths of their fellow farmers who were pushed to commit suicides, the common response we received was “His family would suffer and he did not think about them. It was his bad luck. Poor guy.”  We asked if the MFIs could have pushed them to suicide by their aggressive collection practices, they replied “We know that only some of the stories [of suicides] are real and others are not. For example, a story of suicide reported in a village close-by was an accidental death, while TV showed it as a suicide”. But the others were quick to point out “How do you know? We only know in our village nobody committed suicide”. On MFI staff harassing the borrowers, they said, “Nobody can enter our village and harass us or use foul language against our women and get away with it. We would have not allowed such things to have happened in our village”.

Beyond the MFI

Finally we were curious to know if they were still repaying the MFI loans.   They replied, “No, when the MFI person came, we said, we can’t pay this week and he went away silently and came back next week.”  However in Allagadda, the women said they paid up their dues.

We asked them what they would do, if the MFIs were gone or if they stopped giving loans, but they don’t seem to have imagined such a scenario. One common response we got was “Where would the MFIs go?” When we insisted that they imagine such a scenario, they replied that they would somehow borrow from somewhere or someone and manage to continue, but they did not have a clear alternative.

We had to cut our visit short because of the ensuing political situation, but we believe this visit offered a perspective that was worth sharing.

Over the last few years, microfinance has attracted a large number of equity and debt investors. The Andhra Pradesh ordinance however has resulted in investors suddenly pulling away from this sector, many having taken to adopting a wait and watch approach at a time when their intervention would be most crucial.

It is a turbulent time for microfinance.  IFMR Capital shares the concerns  of  the sector.  We have been carefully monitoring not only our exposures via our portfolio data and field monitoring systems, but also the performance of the microfinance sector as a whole, the debt funding activity and the impact of this crisis on the short term liquidity of MFIs.  While clearly some geographies have been affected,  our surveillance on-the-ground and our portfolio  performance seem to convey a picture that is quite different from what seems to be propagated by media and discussed in investor circles.

We believe sunlight is the best disinfectant and would like to share some information on our portfolio exposures across various geographies and entities.

We have put together a snapshot of our microfinance exposures and portfolio performance across the country  which gives a clearer sense of the picture as we see it today.   To summarise, we have seen no drop in collection efficiencies, either on loans made by us to our MFI partners or on the portfolios underlying the various securitization transactions structured, arranged and invested in by IFMR Capital. Our loans and investments in securitizations show zero over dues. The collection efficiency on the underlying micro-loans securing our assets, stands at close to 99 percent. Our exposures are well diversified over 200 plus districts across various states in the country.

IFMR Capital has partnered with 15 microfinance institutions till date through securitization and through loans made to microfinance institutions. The sector has witnessed capital markets access for MFIs though the development of a rated asset class and a class of new investors such as mutual funds, NBFCs, private wealth and bank treasuries.  It has also seen the evolution of a new transparent benchmark of asset class performance. Our MFIs partners have not only delivered in terms of the data and information rigor of capital markets transactions, but have also consistently demonstrated their ability to service the underlying loans effectively.

A picture is worth a thousand words. The tables and charts below give an insight into the performance of the transactions structured, arranged and invested in by IFMR Capital.