malegam committee report

8/4/2019 Malegam Committee Report

1/65

Report of the

Sub-Committee o f the Centra l Board of

Directors

of Reserve Bank of Ind ia

to Study Issues and Conc erns in the MFI Sec tor

RESERVE BANK OF INDIA

January 2011


2/65

1

1 Introduction1.1 The Boa rd of Direc to rs of the Reserve Bank of India , at its me et ing he ld o n

Oc tober 15, 2010 forme d a Sub -Com mittee of the Boa rd to stud y issuesand concerns in the microfinance sector in so far as they related to the

entities reg ula ted by the Bank.

1.2 The c om position of the Sub -Com mittee wa s a s und er:-Shri Y.H. Ma leg am Cha irma nShri Kum ar Ma ng a lam BirlaDr. K. C. Cha krabartySmt. Sha shi Ra jag opa lanProf. U.R. Ra oShri V. K. Sha rma (Exec utive Direc to r) Me mb er Sec reta ry

1.3 The terms of refe renc e of the Sub-Com mittee we re as under:-1. To review the d efinition of mic rofinanc e and Micro Financ e

Institutions (MFIs) for the purpose of regulation of non-bankingfinance companies (NBFCs) undertaking microfinance by theReserve Bank of Ind ia a nd m ake ap prop riate rec om me nd a tions.

2. To e xamine the p reva lent p rac tices of MFIs in reg a rd to inte restrates, lending and recovery practices to identify trends thatimp inge on borrow ers interests.

3. To d elinea te the o b jec tives and sc op e o f reg ula tion o f NBFCsundertaking mic rofinanc e b y the Reserve Ba nk and the regulatoryfra me wo rk need ed to a c hieve tho se o bjec tives.

4. To e xam ine a nd m a ke a pp rop riate rec om me nda tions in reg ardto a pp lica bility of m one y lend ing leg isla tion of the Sta tes andother releva nt la ws to NBFCs/ MFIs.

5. To e xa mine the role tha t a ssoc iations and b od ies of M FIs c ouldp la y in enhanc ing transpa renc y disc losure a nd b est prac tice s

6. To rec om me nd a grieva nc e redressa l ma c hinery that c ould b eput in place for ensuring adherence to the regulationsreco mmended at 3 ab ove.

7. To e xam ine the c ond itions und er which loa ns to M FIs c an beclassified as priority sector lending and make appropriaterecommendations.


3/65

2

8. To c onsider a ny other item tha t is releva nt to the te rms ofreference.

2 The Mic rofinanc e sec tor

2.1 Microfinance is an economic development tool whose objective is toassist the poor to work their way out of poverty. It covers a range ofservices which include, in addition to the provision of credit, many otherservices suc h a s savings, insuranc e, m oney transfers, counseling , etc .

2.2 For the purp oses of this rep ort, the Sub -Com mittee ha s c onfined itself toonly one aspect of Microfinance, namely, the provision of credit to low-inc om e groups.

2.3 The p rovision of c red it to the Microfinanc e sec tor is ba sed on thefollowing postulates:

a) It addresses the concerns of poverty alleviation by enabling thepo or to wo rk their wa y out of p overty.

b) It p rovides c red it to tha t sec tion of soc iety that is unab le to ob ta inc red it a t rea sona b le ra tes from tra d itiona l source s.

c ) It enables womens empowerment by routing credit directly towomen, thereby enhancing their status within their families, thec om munity and soc iety at large .

d) Easy ac c ess to c red it is mo re imp ortant fo r the p oo r tha n c hea percredit which might involve lengthy bureaucratic procedures anddelays.

e) The p oo r a re o ften no t in a p osition to offer c olla teral to sec urethe c red it.

f) Given the imp erfec t m a rket in which the sec tor ope ra tes and thesmall size o f individ ua l loa ns, high transa c tion c osts a reunavoidable. However, when communities set up their owninstitutions, suc h as SHG fed erations and c o-operat ives thetransaction costs are lower.

g) Tra nsac tion costs, c an be reduc ed throug h ec ono mies of sc a le.However, increases in scale cannot be achieved, both forindividual operations and for the sector as a whole in theab senc e o f c ost rec overy and profit inc entive.


4/65

3

2.4 Given the above considerations, the essential features of credit forMicrofinanc e w hic h have evolved are as under:-a) The b orrow ers a re low -inc om e g roups.b) The loa ns a re for sma ll amounts.

c ) The loa ns a re w ithout c olla tera l.d) The loa ns a re ge nerally ta ken for inc om e-ge nerating a c tivities,although loans are also provided for consumption, housing andother purpo ses.

e) The te nure o f the loa ns is short.f) The freq uenc y of rep ayme nts is grea ter tha n for trad itional

c om me rc ial loans.

2.5 The p layers in the Microfinanc e sec to r c an b e c lassified as fa lling into

three m a in groupsa ) The SHG-Ba nk linkage Mo d el ac c ounting for about 58% of theoutsta nd ing loa n portfolio

b) Non-Banking Fina nc e Co mp a nies a c c ounting for a bout 34% ofthe o utsta nd ing loa n po rtfolio

c ) Othe rs inc lud ing trusts, soc ieties, etc , a c c ounting for the ba lanc e8% of the outstanding loan portfolio. Primary Agricultural Co-op erative Soc ieties numb ering 95,663, covering every village inthe country, with a combined membership of over 13 crores and

loans outstanding of over Rs.64, 044 crores as on 31.03.09 have amuch longer history and are under a different regulatoryfra me wo rk. Thrift and c red it c o-op eratives a re sc a ttered a c rossthe country and there is no centralized information availableab out them.

2.6 The SHG-Ba nk Linkag e Mo d el was p ione ered by NABARD in 1992. Und erthis mo de l, wom en in a villa ge a re enc oura ge d to fo rm a Self help Group(SHG) a nd mem b ers of the G roup reg ularly c ontribute small savings tothe Group . These savings which fo rm a n ever growing nuc leus a re lent b ythe group to members, and are later supplemented by loans providedby banks for income-generating activities and other purposes forsusta inab le livelihood p rom ot ion. The Group ha s we ekly/monthlymeetings at which new savings come in, and recoveries are made frommem bers toward s the ir loa ns from the SHGs, their federat ions, and banks.


5/65

4

NABARD provides g rants, tra ining and c a pa c ity building assista nc e to SelfHelp Promoting Institut ions (SHPI), which in turn ac t a s fa c ilita to rs/ inte rmed ia ries for the forma tion and c red it linka ge o f the SHGs.

2.7 Under the NBFC model, NBFCs encourage villagers to form Joint LiabilityGroup s (JLG) a nd give loa ns to the individ ua l mem b ers of the JLG. Theindividual loans are jointly and severally guaranteed by the otherme mb ers of the Group . Ma ny of the NBFCs op erating this mo del sta rtedoff a s non-profit entities p roviding mic ro-c red it a nd othe r servic es to thepoor. However, as they found themselves unable to raise adequateresources for a rapid growth of the activity, they converted themselvesinto for-profit NBFCs. Others ente red the field d irec tly as for-profit NBFCssee ing this as a viab le b usiness p rop osition. Signific a nt amounts of p rivate

eq uity funds have c onseq uently b een a ttra c ted to this sec tor.

3 The need for regula tion3.1 All NBFCs a re c urrently regula te d by Reserve Bank und er Cha p te rs III-B, III-

C a nd V of the Reserve Bank of Ind ia Ac t. There is, however, no sep ara tec a teg ory c rea ted for NBFCs op erating in the Microfina nc e sec tor.

3.2 The ne ed for a sep a ra te c a teg ory of NBFCs op erating in theMic rofina nc e sec tor a rises for a num b er of rea sons.

3.3 First, the borrowers in the Microfinance sector represent a particularlyvulnerab le sec tion o f soc iety. They lac k ind ividua l ba rga ining pow er,have inadequate financial literacy and live in an environment which isfragile and exposed to external shocks which they are ill-equipped toabsorb. They can, therefore, be e asily exploited .

3.4 Sec ond , NBFCs op erating in the Mic rofinanc e sec tor not o nly c om peteamo ngst the mselves but a lso d irec tly c om pete with the SHG-Ba nkLinkag e Prog ra mm e. The p rac tice s they a d op t c ould ha ve a n ad verseimp ac t on the p rog ra mm e. In a representa tion m ad e to the Sub-Com mittee b y the Go vernment of And hra Pra de sh, it ha s b een a rgue d ,tha t the MFIs a re rid ing p igg y-b ac k on the SHG infra struc ture c rea tedby the programme and that JLGs are being formed by poachingmem b ers from existing SHGs. Ab out 30% of MFI loa ns a re p urpo rte d ly in


6/65

5

And hra Prad esh. The Mic rofinanc e in Ind ia- A Sta te of Sec to r Rep ort 2010a lso says tha t there a re m a ny rep orts of SHGs sp litting and bec om ingJLGs to a va il of loa ns from MFIs. The A.P. Governme nt ha s a lso sta te d tha tas the loans given by MFIs are of shorter duration than the loans given

under the p rog ramm e, rec ove ries by SHGs a re a dversely affec ted a ndloa ns given b y the SHGs a re b eing used to rep a y loa ns g iven b y MFIs.While we did not, as committee, examine each of these issues in depth,the fact that these complaints have been made reinforces the need fora sep arate a nd fo c used reg ulation.

3.5 Third ly, cred it to the Microfinanc e sec tor is a n imp ortant p lank in thescheme for financial inclusion. A fair and adequate regulation of NBFCswill enco ura ge the g row th of this sec tor while a de qua tely protec ting the

interests of the b orrowers.

3.6 Fourth, over 75% of the finance obtained by NBFCs operating in thissec to r is p rovided by banks and financ ial institut ions inc luding SIDBI. As a t31 st Ma rc h 2010, the a gg reg a te a mo unt outsta nding in resp ec t o f loa nsgranted by banks and SIDBI to NBFCs op erat ing in the M icrofinanc esector amounted to Rs.13,800 crores. In addition, banks were holdingsec uritized pa per issued by NBFCs for an a mount of Rs.4200 c rores. Ba nksand Financial Institutions including SBIDBI also had made investments in

the eq uity of suc h NBFCs. Though this exposure may no t b e signific a nt inthe context of the total assets of the banking system, it is increasingrapidly.

3.7 Finally, given the need to encourage the growth of the Microfinancesector and the vulnerable nature of the borrowers in the sector, theremay be a need to give special facilities or dispensation to NBFCsoperating in this sector, alongside an appropriate regulatory framework.This will be fac ilitat ed if a sep ara te c a tegory of NBFCs is c rea ted for thispurpose.

3.8 We would therefore rec om mend that a sepa rate c atego ry be c reated forNBFCs operating in the Microfinance sector, such NBFCs beingdesigna ted as NBFC-MFI.


7/65

6

4 Definition4.1 Onc e a sep a ra te c a teg ory of NBFC-MFI is c rea ted , it b ec om es nec essa ry

to p rovide in the regulat ions a definition for suc h NBFCs. This definitionmust inc orpo ra te the d istinctive fe a tures of a NBFC-MFI.

4.2 The Sub-Co mmittee therefore recom mend s that a NBFC-MFI may bedefined a s

A c om pa ny (other than a c omp any licensed under Sec tion 25 of theCompanies Act, 1956) which provides financial services pre-dominantlyto low-income borrowers with loans of small amounts, for short-terms, onunsecured basis, mainly for income-generating activities, withrepayment schedules which are more frequent than those normallystipulated by commercial banks and which further conforms to the

reg ulations spec ified in that beha lf .

5 Reg ulations to be spec ified5.1 A stud y of 9 la rge and 2 small NBFC-MFIs shows tha t loa ns c onstitute an

average of 95% of total assets (excluding cash and bank balances andmo ney market instrume nts). We ma y, therefore, a c c ep t tha t a NBFC p re-dominantly provides financial services to the Microfinance sector if itsloans to the sector constitute not less than 90% of its total assets(excluding c ash and ba nk ba la nc es a nd mo ney m a rket instrume nts). It is

also necessary to specify that a NBFC which is not a NBFC-MFI shall notbe permitted to have loans to the Microfinance sector which exceed10% of its to ta l assets.

5.2 Mo st MFIs c onsid er a low -inc om e b orrow er as a bo rrow er who b elongs toa househo ld w hose a nnua l inc om e d oe s not e xce ed Rs.50,000/ -. This is area sonab le d efinition and c an b e ac c ep ted.

5.3 a) Currently, most MFIs give individual loans which are between Rs.10,000 a nd Rs. 15,000. Howeve r, some la rge NBFCs a lso g ive la rge r loa ns,even in excess of Rs.50,000 for special purposes like micro-enterprises,housing a nd ed uc ation.b) It is imp ortant to restrict the size of individ ua l loa ns a s la rger loans

can lead to over-borrowing, diversion of funds and size of


8/65

7

repayment installments which are beyond the repaymentc ap ac ity of the bo rrowe r.

c ) It is, therefo re, sug gested tha t the size of a n individua l loa n shouldbe restricted to Rs.25,000. Further, to prevent over-borrowing, the

aggregate value of all outstanding loans of an individualborrower should a lso be restric ted to Rs. 25,000.

5.4 a) MFIs normally give loans which are repayable within 12 monthsirrespective of the amount of the loan. However, the larger theloa n, the large r the a mo unt of the rep aym ent insta llme nt, and alarge installment may strain the repayment capacity of theb orrow er and result in eve r gree ning or multip le borrow ing. At thesame time, if the repayment installment is too small, it would

leave cash with the borrower which could be directed to otheruses and not be available for repayment when repayment isdue.

b) There has, therefore, to b e a linka ge be twe en the am ount o f theloa n a nd the te nure o f the loa n. It is, therefo re, sugge sted tha t forloans not exceeding Rs. 15,000, the tenure of the loan should notbe less than 12 months and for other loans the tenure should notb e less tha n 24 months. The b orrow er should ho we ver ha ve theright of prep a yme nt in all c ases without a ttrac ting p ena lty.

5.5 a) Low-income borrowers often do not have assets which they canoffer as c olla teral, a nd it is imp ortant to ensure tha t in the event o fd efa ult, the borrow er d oe s not lose p ossession o f a ssets which s/ hema y need for her/his c ontinued existenc e.

b) It is, therefore, suggested that all loans should be withoutcollateral.

5.6 a) It is often argued that loans should not be restricted to incomegenerating activities but should also be given for other purposessuch as repayment of high-cost loans to moneylenders,education, medical expenses, consumption smoothing,acquisition of household assets, housing, emergencies, etc. Arecent study by Centre for Microfinance of borrowers inHyderabad indicates that Microfinance is useful in smoothening


9/65

8

consumption and relieving seasonal liquidity crises that visit poorfam ilies a nd tha t it obvia tes the ne ed for high-co st b orrow ing frominformal sources.

b) The need for loa ns for the a bove purposes c a nnot b e d enied . At

the same time there a re pow erful arguments why loa ns b y NBFC-MFIs should b e c onfined to inc om e-ge nerating ac tivities.i. Firstly, the main objective of NBFC-MFIs should be to

enable borrowers, particularly women to work their wayout of poverty by undertaking activities which generatead d itional inc om e. This ad d itional inc om e, afte rrepayment of the loan and interest, should provide asurplus which can augment the household income,enab le c onsumption smoo thing a nd reduce de pe ndenc e

on the mo neylend er.ii. Sec ond ly, if the loa ns a re no t used for rep ayme nt o f high-cost borrowing, but are used for consumption, they will infac t a d d to the financ ia l burden o f the household a s therewill be no additional source from which the loan andinterest thereon c an be rep aid.

iii. Third ly, bo rrow ing for non-inc om e ge nerating purposesmay tempt borrowers to borrow in excess of theirrepa yment c ap ac ity.

iv. Finally, if there is no identified source from which interestand installment can be paid, the rate of delinquency willinc rease. This add itiona l c ost will push interest ratesupwards and may even result in the use of more coerciveme thod s of reco very.

c ) Therefore, a ba la nc e ha s to b e struc k b etw ee n the b ene fits ofrestricting loans only for income-generating purposes andrecognition of the needs of low-income groups for loans for otherpurposes.

d) Ac c ording to Ac c ess to Financ e in And hra Prad esh, 2010,CMF/ IFMR, Chenna i the usage of loa ns g iven b y JLGs and SHGsis as under:


10/65

9

Sr.No. Partic ulars JLG% SHG%i) Inc om e gene ra tion 25.6 25.4ii) Rep a yme nts of old

debt25.4 20.4

iii) Hea lth 10.9 18.6iv) Home

improvement22.1 13.0

v) Ed uc a tion 4.4 5.7vi) Others 11.6 7.9

e) We would however suggest that not more than 25% of the loansgra nted by MFIs should be for non-inc om e ge nerating p urposes.

5.7 a) Currently, some MFIs recover loans by weekly installments whileothe r MFIs rec ove r loa ns b y monthly insta llments. The rules mad eunder the Ordinance issued by the Andhra Pradesh Governmentspecify that recovery should be made only by monthlyinstallments.

b) In a representation made by the Government of Andhra Pradeshto the Sub-Com mittee it has b een argued that bo rrow ers oftenhave uncertain levels of income flows and they are put to greathardship to mobilize, accumulate and service a weekly

repayment commitment. It has also been stated by some MFIsthat they are able to reduce costs by moving from a weeklysystem of rep ayme nt to a mo nthly system of rep a yme nt.

c ) On the other hand, others have argued that some income-ge nera ting a c tivities provid e a c onstant flow of c a sh a nd lea vingidle c a sh in the ha nd s of borrow ers increa ses the risk tha t the c ashmay be diverted to purposes other than repayment of loans. Awe ekly rep ayme nt sc hed ule a lso m ea ns tha t the e ffec tive interestc a n be red uc ed . How ever, N. Sriniva sa n in the 2010 Mic rofina nc e

Ind ia Rep ort argues tha t there is eno ugh e videnc e to suggest tha trep ayme nt rate s do not ma teria lly suffer if the rep ayme nts a re seta t fortnight ly or mo nthly inte rva ls.

d) In our opinion, each purpose for which a loan is used wouldgene ra te its ow n p a tte rn of c ash flow s. Therefore, the rep a yme ntpattern should not be rigid but should be so designed as to be


11/65

10

most suitable to the borrowers circumstances. We would,therefore, sugg est tha t w hile M FIs should b e e nc ourag ed to mo veto a monthly repayment model, freedom should be given to theMFI to fix a p a ttern of rep a yme nt which c an be we ekly, fortnight ly

or mo nthly dep end ing up on the nature of the loa n. The c hoice ofa weekly, fortnightly or monthly repayment schedule should beleft to the b orrow er to suit his/ her ind ividua l c irc umsta nc es.

5.8 We have observed that some MFIs operate not merely as providers ofc red it but a lso p rovide o the r servic es to the b orrow ers and others. Theseservices include acting as insurance agents, acting as agents for thesuppliers of mobile phones and telecom services, acting as agents forthe sale of household products, providing agricultural advisory services

etc . While these servic e c an profita b ly be p rovide d b y MFIs a long w iththe supp ly of c red it, there is a risk tha t g iven the vulnerab le na ture of theborrower and his/her inadequate negotiating power, an element ofcompulsion may creep in unless the provision of these services isreg ulate d . It is, the refo re, nec essa ry tha t the reg ulato r limit the na ture ofservices which can be provided, as also the income which can begenerated from such services, the latter as a percentage of the totalinc om e o f the MFIs.

5.9 We would, therefore, rec om mend that a NBFC c lassified as a NBFC-MFIshould satisfy the following c ond itions:a) Not less than 90% of its tota l assets (other than c ash and ba nk

balances and money market instruments) are in the nature of qua lifying assets.

b) For the purpose of (a) ab ove , a qua lifying asset shall me an aloan whic h satisfies the following c riteria:-i. the loan is given to a bo rrowe r who is a me mb er of a

household whose annual income does not exceed Rs.50,000;

ii. the amount of the loan do es not exc eed Rs. 25,000 andthe total outstanding indebtedness of the borrowerincluding this loan a lso d oes not e xc eed Rs. 25,000;

iii. the tenure of the loan is not less than 12 months where theloan amount d oes not exc ee d Rs. 15,000 and 24 months in


12/65

11

other cases with a right to the borrower of prepaymentwithout pena lty in a ll ca ses;

iv. the loan is without c olla teral;v. the ag gregate am ount of loans given for inc om e

generation purposes is not less than 75% of the total loansgive n b y the MFIs;vi. the loan is rep ay ab le by wee kly, fortnightly or mo nthly

installments at the c hoic e o f the bo rrowe r.c ) The income it de rives from other services is in ac c ordance with

the reg ulation spe c ified in that be half.

5.10 We would also rec om mend that a NBFC whic h does not qua lify as aNBFC-MFI should not be pe rmitted to g ive loans to the microfinanc e

sec tor, whic h in the ag greg ate exc eed 10% of its tota l assets.

6 Areas of Conc ernThe advent of MFIs in the Microfina nc e sec tor a ppea rs to ha ve resulted ina significant increase in reach and the credit made available to thesector. Between 31 st March 2007 and 31 st March 2010, the number ofoutstanding loan accounts serviced by MFIs is reported to haveincreased from 10.04 million to 26.7 million and outstanding loans fromabout Rs. 3800 c rores to Rs. 18,344 crores. While this g row th is imp ressive,

a numb er of studies bo th in India a nd a broad have q uestioned whethe rgrowth alone is effective in addressing poverty and what the adversec onseq uenc es of a too rap id g row th might b e. In pa rtic ular, in theInd ia n c onte xt, sp ec ific a rea s of c onc ern have bee n identified : Theseare:a) unjustified high rates of interestb) lac k of transpa renc y in interest rate s and othe r cha rges.c ) multip le lend ingd) upfront c ollec tion of sec urity dep ositse) over-borrowingf) ghost b orrow ersg) c oercive metho d s of rec overy

7 Pricing of Interest


13/65

12

7.1 There is universa l ag ree ment tha t the p ricing o f inte rest c ha rges a ndother terms and conditions should be affordable to clients and at thesame time susta inab le fo r MFIs.

7.2 The d iffic ulty in ma inta ining a ba lanc e b etw ee n the tw o a rises b ec ausethe costs of credit delivery are relatively flat, that is, the delivery cost perloan remains more or less the same, irrespective of the size of the loan,wherea s the incom e g ene ra ted b y the loa n va ries with its size. Therefo re ,when a uniform rate of interest is used , la rger loa ns will yield a p rofit w hilesmaller loans will show a loss. In the circumstances the options before areg ula tor a re limited .

7.3 Given the vulnerable nature of the borrowers, it becomes necessary to

imp ose som e fo rm o f inte rest ra te c ontrol to p revent e xploita tion. Theea siest a nd simplest form of c ontrol wo uld be a n interest ra te c a p but thishas its own drawbacks, as it could result in MFIs not providing serviceswhere the loss is unsustainable, or the mix of services being skewed infavour of larger loans. Moreover, it would be unfair to the MFIs when costof fund s is volatile a nd fo rms a la rge pa rt of the interest c ap . How eve r, toprevent exploitation in individual cases, a ceiling on the rate of interestcharged on individual loans is desirable.

7.4 Another system is to have a margin cap which provides a cap on thedifferenc e b etwee n the am ount cha rged to the b orrowe r and the c ostof funds to the MFI. While this, too, suffers from the drawbacks of aninterest cap, it is fairer to the MFI since it is not exposed to the risk ofvola tility of c ost of funds. It a lso rec og nizes tha t the c ost of fund s c a n va rybetw ee n d ifferent M FIs. We w ould, therefore, suggest tha t suc h a c a p bemandated.

7.5 For the purpose of determining what would be an appropriate margincap, we have examined the financials for the year ended 31 st March2010 of nine large MFIs which c ollec tively ac c ount fo r 70.4% of the c lients,and 63.6% of the loan portfolio of Microfinance provided by all MFIs. Wealso examined the financ ials for the sa me yea r of tw o sma ller MFIs. Theresults of tha t a na lysis a re a s und er:-


14/65

13

a) For the larger MFIs the effective interest rate calculated on theme an of the outstand ing loa n p ortfolio a s a t 31 st Ma rc h 2009 and31 st Ma rc h 2010 ra nged b etwee n 31.02% and 50.53% with a na vera ge o f 36.79%. For the sma ller MFIs the ave rage wa s 28.73%.

b) For the la rger MFIs, the a verag e c ost o f b orrow ings c a lc ula ted onthe mean of the borrowings as at 31 st Ma rc h 2009 and 31 st March2010 ranged between 10.10% and 12.73% with an average of11.78%. For the sma ller MFIs the a ve rag e c ost w as 11.71%

c ) For the la rger MFIs, the a verag e c ost o f b orrow ings c a lc ula ted onthe m ea n of the outsta nding loa n p ortfolio a s at 31 st Ma rc h 2009and 31 st March 2010 ranged between 8.08% and 17.72% with ana ve rag e of 13.37% For the smaller MFIs it wa s 11.94%

d) For the larger MFIs, the staff cost as a percentage of the mean

outstanding loan portfolio as at 31st

March 2009 and 31st

March2010, ranged between 5.94% and 14.27% with an average of8.00%. For the smaller MFIs it was 4.46%

e) For the larger MFIs, the overheads (other than staff costs) as apercentage of the mean outstanding loan portfolio as at 31 st March 2009 and 31 st March 2010, ranged between 2.46% and8.87% with a n a ve rage of 5.72%. For the sma ller MFIs it was 3.63%.

f) For the larger MFIs, the p rovision fo r loa n losses a s a perc enta ge o fthe mean outstanding loan portfolio as at 31 st March 2009 and

31st

March 2010 ranged between 0.09% and 7.23% with ana ve rag e of 1.85%. For the smaller MFIs it w as 1.07%.g) For the larger MFIs, the profit before tax as a percentage of the

mean outstanding loan portfolio as at 31 st March 2009 and 31 st March 2010 ranged between 4.66% and 17.02% with an averageof 10.94%. For the smaller MFIs it wa s 9.40%.

h) For the larger MFIs, the d eb t/ eq uity ra tio, as a t 31 st March 2010ranged between 2.24 and 7.32 with an average of 4.92. For thesma ller MFIs it wa s 5.61. If we a ssume a c a p ital adeq ua c y of 15%,the resultant ra tio would b e 5.67.

7.6 a) In c onsidering the sta ff and ove rhea d c osts, three fac tors nee d tobe noted:

i. While the cost of the field staff may be largely variablewith the size of the loan portfolio, the cost of the other


15/65

14

overheads may not vary in the same proportion.Therefore, with inc rea se in sc a le, the c ost a s a p erce nta geof the outstanding loan portfolio should decline in thefuture.

ii. The la st few ye ars ha ve witnessed a ve ry ra p id g row th inthe operat ions of the MFIs. Thus, in 2009-10 a lone , theout sta nd ing loa n p ortfolio of MFIs g rew by 56%. To ac hievethis growth, there has been a rapid expansion in thebranch network and development costs have beeninc urred befo re the b ranc hes b roke eve n. Thisdevelopment cost is included in the staff and overheadcosts. If these are excluded, the costs as a percentage ofthe me an o utstand ing loan p ortfolio w ould be low er.

iii. Seve ra l MFIs ha ve a ssigned / ec uritized a signific a ntportion of the ir portfolio. Therefo re, while the size o f theportfolio is red uc ed , the c osts rem ain the same a s the MFIscontinue to operate as agent for collection for thepurc ha sers of the sec uritized pap er. Co nseq uently, if therates are to be calculated on the gross portfolio, both therate of interest on lending as also the cost percentagewo uld b e low er.

b) The fa c tors referred to in (a ) (ii) and (a ) (iii) ab ove ma y pa rtly

a c c ount for the fac t that the study referred to in pa ra 7.5 a bo ve,shows that the overhead costs as a percentage of outstandingloans is higher in the case of larger MFIs as compared to smallerMFIs.

7.7 Based on the above study, we have attempted a normative coststruc ture w hic h c a n form the b asis for a ma nda ted ma rgin ca p as unde r:


16/65

15

% of LoanPortfolio

(a ) Sta ff Costs (sa y) 5.00(b) Overhea ds (other tha n sta ff c osts) sa y 3.00

(c ) Provision for loa n losses, say 1.00Sub-total 9.00(d ) Return on Equity (say):

15% post tax i.e. 22.6107% pre-tax on15% of Loan Portfolio

3.39

Tota l interna l c ost 12.39(e) Co st of Fund s (sa y)

12% on borrowings i.e. 85% of 12% onLoan Portfolio

10.20

Tota l of internal and externa l c osts 22.59Round ed off to 22.00 7.8 It ma y, therefore, be ma nda ted that the m argin c a p should be 10% ove r

the cost of funds for the larger MFIs i.e. those with a loan portfolioexceeding Rs. 100 crores and 12% over the cost of funds for the smallerMFIs i.e. those with a loa n p ortfolio no t e xce ed ing Rs. 100 crores. This c a pwill be calculated on the average outstanding loan portfolio. While thismargin cap may be considered slightly low in the context of the present

c ost structure, it ca n be justified on the fo llow ing g round s:-a) There is no rea son w hy the c ost of d eve lop me nt a nd expa nsionincluded in the present costs should be borne by currentborrowers.

b) As the size of the operations increase, there should be greatereconomies of scale and consequent reduction in costs in thefuture.

c ) In the last few years, not only has the growth of MFIs beenfinanced out of interest charged to borrowers but they have alsomade profits which are in excess of what can be considered asrea sona b le, g iven the vulnerab le na ture of the borrow ers. They,therefore, have the capacity to absorb these higher costs till thegrowth rates stabilize and they achieve the desired scale ofoperations.


17/65

16

7.9 The ma rgin ca p m ust be c onside red on a n ag grega te level and no t asapp lic a b le to ind ivid ua l loa ns. The MFIs must be g iven the free dom todevise individual products and price them differently as also applyd ifferent ra tes in d ifferent reg ions so long as the a ggreg a te m argin c a p is

maintained . This will a lso fa c ilitat e m onito ring by the regulato r on thebasis of the Annua l Financ ia l Sta tement s. If the reg ulato r find s onexam ina tion of the Annua l Financ ial Sta tem ents tha t the a verag e m arginhas excee d ed the ma rgin ca p the reg ulato r c an ta ke suc h ac tion a s isc onside red nec essa ry. Several op tions a re a va ila b le. For exam ple,a) The M FI ma y be a llow ed to keep the e xc ess inco me a pa rt a nd

adjust this in determining the interest rate structure in thesucc eed ing yea r

b) The reg ula tor c an c rea te a Borrow er Prote c tion Fund and the MFI

ma y b e asked to t ra nsfer the exc ess inco me to the Fund . TheFund can be used for such purposes such as financial literacy,etc.

c ) Pena lty c ould b e imp osed on the MFI.d) Access to priority sector loans may be suspended for a period of

time d uring w hic h com me rc ia l loa ns c ould still b e a va ilab le to theMFI to kee p its b usiness going .

7.10 How ever, in a dd ition to the ove rall ma rgin ca p, there should be a c ap of

24% on the individ ua l loa ns.

7.11 We would, therefore, reco mm end that there should be a ma rgin c ap of10% in respect of MFIs which have an outstanding loan portfolio at thebeginning of the year of Rs. 100 crores and a margin cap of 12% inrespe c t of MFIs which have an outstand ing loa n portfolio a t the beg inningof the year of an a mount not exc eeding Rs. 100 c rores. There should alsobe a c ap of 24% on individual loans.

8 Transparenc y in Interest Cha rges8.1 MFIs ge nerally levy a b ase interest c harge c a lc ula ted on the gross va lue

of the loa n. In ad d ition, they often rec ove r a va riety of othe r c harge s inthe form of an upfront registration or enrolment fee, loan protection fee,etc . They a lso rec over an insura nc e p rem ium. It is imp orta nt in the interestof transparency that all stake-holders in the industry including borrowers,


18/65

17

lenders, regulators, etc. should have a better understanding ofc om para tive p ricing by d ifferent MFIs. This req uires the use o f a c om monformat.

8.2 It is, therefore, suggested that MFIs should levy only two charges apartfrom the insura nc e p rem ium. These two c ha rges should c onsist o f anupfront fee towards the processing of the loan which should not exceed1% of the g ross loa n a mo unt, and an interest c ha rge.

8.3 To p rom ote transpa renc y a nd to ma ke c om parisons possib le, theborrow er must know w hat is the e ffec tive interest ra te o n the loa n whic hs/ he ta kes as a lso the other terms like rep a yme nt terms, etc . S/ he should,therefore, be given a loan card which records all these terms and which

is in the loc a l la ngua ge w hich s/ he c a n understa nd . The c a rd should b eused to record acknowledgements for each installment paid by theborrower and the final discharge, duly authenticated by the lender, asa lso sufficient d eta ils to identify the borrow er a s a lso the SHG/ JLG towhich s/ he b elong s. It is a lso ne c essa ry tha t the effe c tive interest ratecharged by the MFI is prominently displayed in its offices and in literatureissued by it and on its we bsite.

8.4 The purpose o f the insura nc e p rem ium is to p rotec t the MFI in the unlikely

event of the death of the borrower during the pendency of the loan.Insurance to serve this purpose may be mandatory but beyond thispurpose should b e op tional. The p rem ium should a lso be rec ove red as apa rt o f the loa n rep aym ent installme nt a nd not up front a nd there shouldbe regulat ions for the p rop er disp osa l of the p olic y proc ee d s in the e ventof the d ea th o f the b orrow er or ma turity of the polic y or for its a ssignme nton the sett lem ent o f the loa n. We have a lso no ticed tha t som e MFIs levyan insurance administration charge. We see no reason why such ac harge should b e levied . MFIs should recove r only the a c tua l c ost ofinsurance.

8.5 We have observed that some MFIs recover a security deposit in cashfrom the b orrow ers. We are informe d tha t no interest is p a id on thisdeposit. As this deposit is recovered up front from the amount of theloan, this amounts to charging interest on the gross value of the loan


19/65

18

whe n only the net amo unt is d isbursed . The p rac tice of sec urity d ep osit,therefore, distorts the interest rate structure and should be discontinued.Further, the a c c ep ta nc e o f suc h d ep osit is not permissible b y the RBI Ac t.

8.6 Tra nspa renc y a nd c om pa ra bility wo uld b e c onsid era tely enha nc ed ifMFIs use a sta nda rd form of loa n a greem ent.

8.7 We wo uld, therefore, rec om me nd that:-a) There should be only three c om po nents in the pricing of the loan,

namely (i) a processing fee, not exceeding 1% of the gross loanam ount (ii) the interest charge and (iii) the insuranc e p rem ium.

b) Only the ac tual c ost of insuranc e should be rec overed and noad ministrative c harges should b e levied .

c ) Every MFI should provide to the bo rrowe r a loan c ard which (i)shows the effective rate of interest (ii) the other terms andconditions attached to the loan (iii) information which adequatelyidentifies the borrower and (iv) acknowledgements by the MFI ofpay ments of installments received a nd the final disc harge. TheCard should show this information in the local languageunderstood by the bo rrowe r.

d) The effec tive rate of interest c harged by the MFI should beprominently displayed in all its offices and in the literature issued

by it and o n its website.e) There should be ad eq uate reg ulations regarding the ma nner inwhich insurance premium is computed and collected and policyproc eed s dispo sed off.

f) There should not be any recove ry of sec urity de posit. Sec urityde po sits alread y c ollec ted should be returned .

g) There should be a standard form of loan ag reem ent.

9 Multiple- lending, Over-bo rrowing and Ghost-bo rrowe rs9.1 The p rob lem s c onne c ted with multip le-lend ing , over-borrow ing a nd

ghost-borrowers are interlinked and can be considered collectively.There is c onsid erab le e videnc e tha t these p ra c tices a re w idely preva lentand various rea sons have b een a dva nc ed for the sam e.


20/65

19

9.2 It has been suggested that with the development of active competitionbetween MFIs there has been a deluge of loan funds available toborrowers which has fuelled excessive borrowing and the emergence ofundesirable practices. It is also claimed that the emergence of ring

leaders as key intermediaries between MFIs and potential customers hasd istorted ma rket d isc ip line a nd go od lend ing p rac tice s. There a re repo rtsthat ghost loans have become epidemic in some states. Finally, it isbelieved that in consequence of over-borrowing, default rates havebeen climbing in some locations but these have not been disclosedbe c ause of e ver-greening and multiple lending.

9.3 There c a n be several othe r rea sons for multip le-lend ing a nd over-borrow ing. How eve r, three ma jor rea sons ma y be note d .

a) The loa ns a re g iven fo r inco me -gene ra tion but ofte n there isinad equa te time given to the b orrowe r be tween the grant of theloa n and the c om me nc em ent of the rep a yment sc hed ule. Thisgives her/him insufficient time to make the institutionalarrangements necessary to be in a position to generate income.In the absenc e o f suc h a period of m orato rium, it is likely tha t thefirst few installments, particularly when the repayment is weekly,would be paid out of the loan itself, thus reducing the amounta va ilab le for investment or pa id out of ad d itional b orrow ing . It is,

therefore, suggested that borrowers should be given areasonable period of moratorium between the disbursement ofthe loa n and the c om me nc em ent of rep aym ent. This pe riodshould no t b e less tha n the freque nc y of rep a yment. Thus, a loa nrepayable weekly would have a moratorium period of not lessthan one week while a loan repayable monthly would have amo ra torium p eriod of no t less tha n one mo nth.

b) MFIs ofte n use e xisting SHGs as the ta rge t to ob ta in newborrowers. This no t only inc rea ses p rofit but a lso red uc es the irtransac tion c osts. These b orrow ers a re, therefo re, tem p ted to t a kea dd itiona l loa ns be yond their rep aym ent c a pa c ity.

9.4 Ma ny of the a bove adverse fea tures wo uld be m inimized if bo rrow ers a rea llow ed to bec om e me mb ers of o nly one SHG/ JLG a nd a lso if MFIs a re


21/65

20

not allowed to give loans to individuals except as members of a JLG.Suc h a regula tion wo uld ha ve two a dva ntag es nam ely,a) Multiple lend ing a nd o ver-bo rrow ing c a n be a voided as the tota l

loa ns g iven to a n ind ividua l c an be mo re ea sily asc ertained and

b) The risk is sha red by other mem b ers of the JLG w ho c a n imp osesom e p ee r p ressure ag a inst over-b orrow ing.

9.5 Over borrowing can also be reduced if not more than two MFIs lend tothe same borrow er.

9.6 It is also necessary to provide that if a MFI gives an additional loan to aborrow er who a lrea dy has a n outsta nd ing loa n from a SHG/ MFI, wherebythe prescribed aggregate borrowing limit is exceeded or gives an

additional loan when existing outstanding loans have been given by twoMFIs, then recovery of the additional loan shall be deferred till the earlierloa ns a re fully rep a id.

9.7 We would, therefore, rec om me nd that:- a) MFIs should lend to an individual bo rrower only as a me mb er of a

JLG and should have the responsibility of ensuring that theborrower is not a m em be r of ano ther JLG.

b) a bo rrowe r c anno t be a me mbe r of mo re than one SHG/ JLG.

c ) not mo re than two MFIs should lend to the sam e bo rrower.d) there must be a minimum period of moratorium between thegrant of the loan a nd the c omm enc em ent of its repa yme nt.

e) rec overy of loan given in violation of the regulations should bedeferred till all prior existing loa ns are fully rep aid .

9.8 Gho st b orrow ers generally arise in two sets of c irc umsta nc es:-a) when the borrower on record is a benami for the real borrower

a ndb) whe n fictitious loa ns a re rec orded in the b oo ks.

9.9 The first type of Gho st Borrow er is oft en used a s a d evic e for multip lelend ing o r ove r- bo rrow ing . This c an b e c ured only by a bett er disc ipline inthe system of identification and data base of borrowers and better follow-up b y the field w orker.


22/65

21

9.10 The sec ond type o f Gho st Borrow er can p ose a muc h g rea ter system icproblem as it would create fictitious assets and is often used to recordfic titious rep ayme nts a nd thus hid e the ac tua l leve l of d elinquenc ies.

9.11 One of the ways by which the problem of Ghost Borrowers can beminimized would be by better control in the structuring and disbursementof loa ns. These func tions should no t b e e ntrusted to a single individua l butshould need the c ollec tive a c tion o f mo re tha n one individua l and shouldbe done at a central location. In addition, there should be closersup ervision o f the d isb ursem ent func tion.

9.12 We would, therefore, rec om me nd that

all sanctioning and disbursement of loans should be done only at acentral location and more than one individual should be involved in thisfunction. In addition, there should be close supervision of thedisbursement function.

10 Credit information Bureau10.1 An essential element in the prevention of multiple-lending and over-

borrow ing is the ava ilab ility of informa tion to the MFI of the existingoutsta nd ing loa n of a pote ntia l b orrower. This is not p ossible unless a

Cred it Information Burea u is esta b lished exped itiously.

10.2 The func tion of the Burea u should no t b e to dete rmine the c red itworthiness of the borrowers. Rather, it should provide a data base tocapture all the outstanding loans to individual borrowers as also thec om position of e xisting SHGs and JLGs. When more than one burea udischarges the role, adequate co-ordination between the bureaus willneed to be estab lished .

10.3 Micro Finance Institution Network (MFIN) formed in November 2009 is anind ustry assoc iation of MFIs which c la ims it ha s 44 mem bers (with anothe r5 in p ipe line) who c ollec tively constitute 80% of the MFI business. Simila rlySa-Dha n is an a ssoc ia tion of c om munity d eve lop me nt financ e institutionswhich a lso inc ludes MFIs within its mem bership. Both institut ions ha ve aCod e of Conduc t for their me mb ers. Both institutions have rep resente d


23/65

22

to us that they are actively working with a Credit Information Bureau tobuild up a system whereby MFIs can report to the Bureau the status of allloans granted by them. Once such a Bureau starts functioning there is norea son w hy multiple lending and over bo rrow ing c a nnot b e c ontrolled .

10.4 The issue is wha t c an b e d one until suc h a Bureau sta rts func tioning. Webelieve that until that time, MFIs should have the responsibility to makereasonable enquiries to find out a prospective borrowers outstandingloans. Given the fact that most loans are given to borrowers in a villageand the fact that MFIs have field staff who have sources of information,this should no t b e too onerous a ta sk.

10.5 We would therefore reco mm end that

a) One or more Cred it Informa tion Burea us be estab lished and beoperational as soon as possible and all MFIs be required tobec ome me mb ers of such bureau.

b) In the me antime , the respo nsibility to ob tain informa tion frompotential borrowers regarding existing borrowings should be onthe MFI.

11 Coerc ive Method s of Rec overy11.1 There a re rep orts tha t MFIs or their em ployees a nd a gent s ha ve used

coercive methods of recovery and similar complaints have been madeby many of the organisations which have made representations to us.While we did not seek any specific evidence about the extent of thismalpractice, the very fact that such claims are widely made makes itob vious that the m atte r need s atte ntion.

11.2 Co ercive m etho d s of rec ove ry a re, to som e e xtent , linked with the issuesof multiple lending and over-lending. If these issues are adequatelyaddressed, the need for coercive methods of recovery would also getsignific a ntly red uc ed .

11.3 The p rima ry responsibility for the p reve ntion of coe rc ive me tho ds ofrec overy must rest w ith the MFIs. They ha ve to ac c ep t resp onsibility forthe good conduct of their employees and if employees or outsourcedworkers misbehave or resort to coercive methods of recovery, severe


24/65

23

penalties must be levied on the MFIs and their management. If this isdone, the managements of MFIs, in their own interest, will establish aprope r Code of Co nduc t for field staff a nd ma ke greate r investme nts inthe tra ining and supervision of the field sta ff to p reve nt suc h oc c urrenc es.

11.4 Coercive m etho ds of rec ove ry also surfac e w hen the g row th of the MFI isfaster tha n its a bility to rec ruit the req uired sta ff of the right q ua lity a nd toprovide them adequate training. It also surfaces when the systems ofc ontrol and inspec tion a re inad eq ua te. These a re a rea s whic h will ha veto b e m onitored b y the reg ula tor.

11.5 It has been suggested that coercive methods of recovery have beenencouraged by the practice of enforcing recovery by recovery agents

visiting the reside nc e of the borrow ers. The And hra Prad esh MicroFinance Institutions (Regulations of Money Lending) Act 2010 drafted bythe Sta te Go vernment inc lud es a list o f a c tions which c onstitute c oe rc ive a c tion . This inc ludes freq uenting the house o r othe r p la c ewhere such person resides or works, or carries on business, or happens tobe. It also provides that all tranches of repayment shall be made bythe SHG o r its me mb ers a t the o ffic e o f the Gram Panc ha yat o r a t apub lic p lac e d esigna ted by the Distric t Co llec tors only.

11.6 We agree that recovery should not be made at the borrowers place ofresidence or business as that may encourage coercive methods ofrecovery. At the same time we believe if the designated place ofrecovery is the Gram Panchayat office or any other place distant fromthe borrowers place of residence or work s/he would need to incuravoida b le time a nd c ost. There are ad va nta ge s in req uiring rec ove ryfrom the group as a whole at a central location and this may bespec ified by the MFI. This will ensure tha t the p rivac y of the group isrespected and that there is sufficient peer pressure on the borrower toma ke the repa yments.

11.7 It is interesting in this context to consider the experience of banks whichin respec t o f their reta il portfolio ha d in the past fa c ed simila r p rob lem s ofcoercive recovery. We believe this problem was significantly reduced bythe follow ing m ea sures:-


25/65

24

a) The size o f their portfolio wa s red uc ed to the levels which theyc ould ad equa tely co ntrol.

b) The use o f out-source d rec ove ry ag ents wa s red uc ed and m oreof their own employees were used for recovery particularly in

sensitive areas.c ) The typ es of p rod uc ts we re e xam ined and rec overy method swe re fine tuned to rec og nize the va rianc es in these p rod uc ts.

d) Tra ining a nd sup ervision we re g rea tly enha nc ede) Compensation methods for staff were reviewed and greater

emphasis was given to areas of service and client satisfactionthan me rely the rate of reco very.Som e of these me thod s c a n b e p rofitab ly used b y MFIs.

11.8 It is also necessary that MFIs are sensitive to the reasons for a borrowersdefault. If this default is of a temporary nature or willful, the MFI mayenforce recovery from other members of the Group but if there areexternal factors beyond the control of the borrower, some time forrec overy may need to b e g iven.

11.9 A key c om p onent in the p revention of co erc ive rec overy is an a de qua tegrievance redressal procedure. It is necessary that there should be agrievance redressal system established by each MFI and for this to be

made known to the borrower in the literature issued, by display in itsoffice s, by p osting on the we b site a nd by prom inent inc lusion in the Loa nCard given to the borrower. In addition, it is necessary that there shouldbe inde pe nde nt a uthorities esta blished to w hom the b orrow er ca n ma kereference.

11.10 It ha s b ee n rep resente d to us tha t Sa-Dha n ha s a t the na tiona l leve l anEthic a l Grieva nc e Red ressa l Co mmittee. Simila rly MFIN has a nEnforc em ent Co mm ittee for d ea ling w ith Co de of Co nduc t violations.While these initiatives are commendable it is necessary that there shouldbe an institution like the O mb udsma n to whom ag grieved bo rrow ers c a nma ke refe renc e. These Omb udsme n should b e loc a ted within ea syrea c h of the b orrow ers.


26/65

25

11.11 One suggestion made is that an officer of the lead bank in each districtc ould be d esigna ted a s the Om bud sma n. This is justified since thebanking sec tor has a la rge e xp osure to MFIs and a lso sinc e the lea d ba nkhas the responsibility to promote financial inclusion in the district. Another

suggestion is that there should be a system of mobile Ombudsmen whowould visit each village by rotation on specified days. Both thesesuggestions need further examination.

11.12 We would, therefore, recom mend that:-a) The responsibility to ensure that c oercive method s of recovery are

not used should rest with the MFIs and they and theirmanagements should be subject to severe penalties if suchme thods are used .

b) The regula tor should monitor whe ther MFIs have a prop er Cod e ofConduct and proper systems for recruitment, training andsupervision of field staff to ensure the prevention of coercivemethods of recovery.

c ) Field staff should not be allowed to ma ke reco very at the plac e ofresidence or work of the borrower and all recoveries should onlybe m ad e at the Group level at a c entral plac e to be d esignated.

d) MFIs should c onsider the exp erienc e of ba nks that fac ed similarproblems in relation to retail loans in the past and profit by that

experience.e) Eac h MFI must estab lish a prop er Grievanc e Red ressal Proc ed ure.f) The institution of indep endent Omb udsme n should be exa mined

and b ased o n such exa mination, an app ropriate mec hanism m aybe rec om me nded by RBI to lead ba nks.

12 Custom er Protec tion Cod e12.1 Between the MFIs and the borrowers, the MFIs have an immeasurably

sup erior ba rga ining p ower. It is, the refore, essentia l tha t MFIs a rec om mitted to follow a Custom er Protec tion Co d e.

12.2 The C onsulta tive G roup to Assist the Poor (CGAP) esta b lished b y theWorld Ba nk a nd supp orted by the 30 develop me nt a ge nc ies and privatefoundations who share a common mission to obviate poverty haspub lished six c ore princ iples for c lient prote c tion in microfinanc e. The


27/65

26

Sma ll Enterprises Educ a tion a nd Prom otion (SEEP) ne tw ork ha s a lsodesigned a template for a consumer protection code of practice toinc rea se transparenc y in microfinanc e c onsume r polic ies and p rac tices.

12.3 Using the material already available from these sources, it should bepossible to prepare a Customer Protection Code which MFIs arema nda ted to a do p t and follow . This c od e c ould have the follow ing c oreprinciples.a) Commitment

A statement to be made by the MFI which articulates the MFIsc om mitment to transp arency a nd fa ir lend ing p rac tic es.

b) Avoida nc e of ove r-inde bte d nessThe c om mitme nt to ta ke rea sona b le step s to ensure tha t c red it is

extended only if borrowers have demonstrated an adequateability to repay the loans and the loans will not put borrowers atsignificant risk of over-indebtedness.

c ) Cap ac ity Building and emp owe rmentThe c om mitment to c ap ac ity building a nd em po wermentthroug h skill tra ining a nd hand holding.

d ) Ap propriate ma rketingThe a ssura nc e tha t non- cred it fina nc ia l prod uc ts ma rketed a re

appropriate.

e) Tra nspa rent a nd Co mp et itive PricingPricing and terms and conditions of the financial product(inc lud ing interest c ha rges, insura nc e p rem ia , fees etc .) which a retransparent and disclosed in a form and language easilyunderstoo d b y the c ustom er and p ricing whic h is rea sona b le, thatis, a ffordab le to the c ustomer and susta inab le fo r the MFI.

f) Ap propriate Collec tion Pra c tic esDebt c ollec tion p ra c tic es which a re no t a b usive o r c oe rc ive.

g ) Ethica l Sta ff Beha viourThe c om mitme nt tha t sta ff will c om ply with high e thica l sta nda rd sin interaction with customers and that there are adequatesafeguards to detect and correct corruption or unacceptablebehaviour.

h) Accountability


28/65

27

A declaration that the MFI will be accountable for strictlycomplying with prudential regulations and preventinginappropriate staff behavior together with details of a timely andresp onsive mec ha nism for grievanc e red ressa l.

i) Priva c y of Client DataThe a ssuranc e tha t p riva c y of c lient da ta will be resp ec ted .

12.4 The Reserve Bank ha s a lrea dy p resc ribed on Sep temb er 28, 2006 b roa dguidelines on fair prac tic es to b e fram ed and ap p roved by the b oa rds ofd irec to rs of a ll NBFCs. The releva nt p rovisions of this Fa ir Prac tic es Cod eneed to be incorporated in the Customer Protection Code which NBFC-MFIs should adopt.

12.5 Simila r provisions should a lso be ma d e app lica b le to b anks and financ ialinstitutions which p rovide c red it to m ic rofinanc e sec tor.

12.6 We would, therefore, rec om mend that the regula tor should pub lish aClient Protection Code for MFIs and mandate its acceptance andob servanc e b y MFIs. This Cod e should inc orpo rate the relevant provisionsof the Fair Practices Guidelines prescribed by the Reserve Bank forNBFCs. Similar provision should also be made applicable to banks andfinanc ial institutions which provide c red it to the mic rofinance sec tor.

13 Improvem ent of efficienc ies13.1 The p urp ose o f reg ula tion should no t b e c onfined me rely to the

prevention of abuses but should also examine methods by which theefficienc y of o perations c a n b e imp rove d . This will benefit bo th the MFIsand the borrowers as it will reduce costs and consequently interestc ha rges a nd a lso inc rea se the volume o f business.

13.2 The key a rea s in improving effic ienc y are:-a) bett er op erating system sb) simp lific ation of doc umenta tion and proc ed uresc ) bett er tra iningd) be tter c orpo rate governanc e


29/65

28

13.3 The o perations of MFIs c a n b e b roa d ly d ivid ed into two a rea s, nam ely,operations at the field level and back office operations. While efficiencyat the field level will result in better service to borrowers and greaterprotection from abuse, efficiency in the back office can result in a

grea ter saving in costs as a lso b et ter c ontrol on the field sta ff. Informa tionTec hno log y is a p ow erful tool in build ing operating systems forid entific ation of bo rrow ers and c om munic ation of da ta a nd nee d s to b efully exploited. It will help in the operation of the Credit InformationBureau, reduce over-borrowing and control delinquency withoutresorting to c oe rc ive me thods. The use o f bio-met rics a nd the UniqueId entific a tion Prog ramm e ho ld g rea t prom inenc e in this a rea .

13.4 Early availability of credit is as important to the borrower as the terms on

which c red it is g iven. Therefo re, the re is a lso the nee d to re-examine theregulatory and other requirements to simplify documentation andreduce delays. Given the small amount of individual loans and theconsequent spread of exposure, the cost saving will more thanc om pensa te for the risk of loss of c ontrol and c onseq uent defa ults.

13.5 We would, therefore, recommend that MFIs review their back officeoperations and make the necessary investments in InformationTec hnology and systems to a c hieve b etter co ntrol, simp lify p roce dures

and reduc e c osts.

14 Sup port to SHGs/ JLGs14.1 The p urp ose o f the forma tion o f SHGs a nd JLGs c anno t b e m erely to

share the liability. More importantly the group is to be seen as the vehiclethrough which skill development and training are imparted to themem bers of the group . A SIDBI sponsored stud y over a seven yea r p eriodfrom 2001-2007 rec ords tha t the re wa s a unanimo us d em and from groupmembers in all villages visited that skill development and training wasrequired for undertaking any income generating activity and that theyfelt that a loa n a lone wo uld not he lp in imp roving the ir livelihoo d .

14 .2 It is also necessary as pointed out in Microfinance India 2010 report, that,a fter the forma tion of g roup s, hand holding is req uired to ensure tha t thegroup functions within the framework of group discipline and financial


30/65

29

disc ipline. The report rec ords tha t the pa st suc c ess of the SBLP was largelydue to NGOs who worked with missionary zeal and motivation but thatthere is evidence that in recent times, this handholding is conspicuous byits ab senc e in both the SBLP and the MFI mod el. Group s forme d witho ut

professional inputs and without the requisite handholding cannot sustainthe financial content of either model and can lead to an increase indefa ults and c onseq uent ab uses in the system .

14.3 In a c om munic a tion da ted Novem ber 22, 2006 to the ba nks, the ReserveBank has also noted that many MFIs supported by banks were notengaging themselves in capacity building and empowerment of thegroups to the desired extent a nd as a result, c ohesiveness and a sense o fpurp ose w ere no t b eing built up in the g roup s forme d b y these MFIs. This

wo uld b e in ad dition to a nd c om pleme ntary to the e fforts of the StateGo vernments in this reg ard .

14.4 In a submission made to us by the Ministry of Rural Development, it hasbeen suggested that in order to make branchless banking models work,banks nee d to re-eng inee r front e nd proc esses and esta b lish a supportarchitecture to provide back-stopping support for cash management,technical training and trouble shooting, back-end business processingand c hannel c ontrol func tions. This a rc hitec ture should c om p rise of

servic e b ranc hes op erating the C BS p la tform a nd netw ork of c ounselingc ente rs. The Nationa l Rural Livelihoo d Mission ha s offered to c o-inve st inthis c onc ep t.

14 .5 We would , therefore, rec om mend tha t unde r both the SBLP mod el andthe MFI model greater resources be devoted to professional inputs bothin the formation of SHGs and JLGs as also in the imparting of skilldeve lopme nt and training a nd g enerally in handholding after the groupis forme d. This would be in ad dition to and c om plem entary to the e ffortsof the State Governme nts in this rega rd. The a rchitec ture suggested bythe Ministry of Rural Deve lopment should also b e exp lored.

15 Corpo rate Size15.1 As indicated earlier, transaction costs can only be decreased if

economies of scale can be achieved. Also, to improve efficiency and


31/65

30

improve control, significant back office investments are needed. It is,therefore, in the interest of the borrowers that MFIs should attain anop timal size a nd c onsolida tion within the industry a ppea rs inevitab le.

15.2 The rep resenta tion ma de to us see m to suggest tha t MFIs which ha ve a ninvestm ent p ortfo lio o f Rs.100 crores or less a re c onsidered as sma ll MFIs.Given a Capital Adequacy ratio of 15% of risk weighted assets, thistranslates to a networth of Rs.15 crores. Currently an MFI being a NBFC isreq uired to have a minimum c ap ita l of Rs.2 c rores. We wo uld sugg est fo ra NBFC MFI this should be increased to a minimum Net Worth of Rs.15crores.

15.3 We would , therefore, recom mend tha t all NBFC-MFIs should have a

minimum Net Worth of Rs.15 crores.

16 Corporate Governanc e16.1 MFIs have twin objectives, namely to act as the vehicle through which

the poor can work their way out of poverty and to provide reasonableprofits to the ir investo rs. These twin ob jec tives c an c onflict unless a fa irba lanc e is ma inta ined betw ee n b oth ob jec tives. This ma kes it essentialtha t MFIs have g oo d system s of Corpo ra te G ove rnanc e.

16.2 Some of the a reas in whic h go od c orpo rate go vernanc e c an b emand ated w ould b e:-a) the composition of the board with provision for independent

directors

b) the responsibility of the board to put in place and monitororga nisa tion leve l po licies for:-(i) the growth of the loan portfolio including its dispersal in

d ifferent reg ions(ii) the ide ntific a tion and forma tion of joint liab ility group s(iii) bo rrow er training a nd ed uca tion programm es(iv) c red it a nd assessme nt p roc ed ures(v) rec overy method s(vi) employee c ode of c onduct(vii) emp loyee qua lity enhanc eme nt prog ram mes


32/65

31

(viii) compensation system for employees including limits onvaria ble pa y a nd the limit therein on we ighta ge forbusiness development and collection efficiency

(ix) c ustom er grieva nc e p roc ed ures

(x) internal aud it and inspec tion(xi) whistle b low ing(xii) sha ring of informa tion with industry b od ies

c ) d isc losures to be ma d e in the fina nc ial sta tem ents inc lud ing:(i) the geographic distribution of the loan portfolio, both in

terms of num b er of bo rrow ers a nd outsta nd ing loa ns(ii) ana lysis of overdues(iii) the a vera ge effec tive rate o f interest, the a vera ge c ost of

funds a nd the a vera ge ma rgin earned(iv) ana lysis of the outsta nd ing loa ns b y na ture of purpose forwhich loa ns we re granted

(v) composition of shareholding including percentageshareho ld ing he ld b y priva te e quity

16.3 We would, therefore, rec om me nd that every MFI be req uired to have asystem of Corporate Governance in accordance with rules to be

spec ified by the Reg ulator.

17 Maintenanc e of Solvenc y17.1 While NBFC-MFIs do not accept public deposits, they have a very large

exposure to the banking system. It is estimated that more than 75% oftheir source of funds comes from the banking system. It is, therefore,necessary to ensure that there are adequate safeguards to maintainthe ir solvenc y. This may be e xamined in three a rea s.

17.2 Firstly, there should be appropriate prudential norms. Currently, since MFIsare not considered as a separate class of NBFCs, no separate set ofp rud ent ial norms ha ve bee n p resc ribed . Thus, loa ns a re c lassified as NPAsif interest o r rep a yme nt is overdue for 180 da ys. This mea ns tha t a loa nwhere repayment is weekly becomes an NPA only when 24 installmentsare overdue .


33/65

32

17.3 Given the small size of individual loans, their large number, their shorttenure, the freq uenc y of repa yment a nd the lac k of c ollate ra l, it is c lea rthat the existing prudential norms for the provision for loan losses are

inadequate and must be replaced by simpler norms which apply to theuniverse o f loa ns and not to ind ivid ua l loa ns.We would, therefore, recommend that provisioning for loans should notbe maintained for individual loans but an MFI should be required tomaintain at all times an aggregate provision for loan losses which shallbe the higher of: i. 1% of the outstand ing loa n portfolio orii. 50% of the ag gregate loan installments which are overdue for

more than 90 days and less than 180 days and 100% of the

aggregate loan installments which are overdue for 180 days ormore.

17.4 Sec ond ly, currently a ll NBFCs a re req uired to ma inta in Ca p ita l Ade quac yRatio to Risk Weighted Assets of 12%. Considering the greater risks in theMicrofina nc e Sec tor, the high-gea ring, and the high ra te o f growth, it isnec essa ry tha t this rat io should b e suita b ly inc rea sed . It is a lso nec essa rythat subject to our comments in para. 21.3 below the total Net OwnedFund s should b e in the form of Tier I Ca p ital.

17.5 We would, therefore, recom mend that NBFC-MFIs be req uired to mainta inCap ital Adeq uac y Ratio of 15% and subjec t to our c om me nt in pa ra. 21.3be low a ll of the Net Owned Funds should be in the form of Tier I Capital.

18 Need for Com pe tition18.1 While regulations are important, they cannot by themselves be the sole

instruments to reduce interest rates charged by MFIs or improve theservic e p rovide d to borrow ers. Ultima tely, this c a n only be d one throug hgreater competition both within the MFIs and without from otherag enc ies op era ting in the Microfinanc e sec tor.

18.2 The a ge ncies op erating in the Mic rofinanc e Sec tor ca n b e b roa d lygroup ed in tw o c la sses na me lya) The SHG-Ba nk Linkage Prog ramme (SBLP) a nd


34/65

33

b) MFIs inc lud ing NBFC-MFIs, trusts, soc ietie s, etc . whereo f NBFC-MFIshold m ore tha n 80% of the outsta nd ing loa n p ortfolio.

18.3 The relat ive sha re o f the se two c lasses in the last three ye a rs as rep orte dby ACCESS is as under:-

Partic ulars FY 2008 FY2009 FY2010 % Gro wthover 2years

No. of Customers

(million)

SBLP 50.8 59.1 64.5 26.96MFI 14.1 22.6 26.7 189.36Tota l 64.9 81.7 91.2 140.52Portfolio Outstanding(Rs. Billion)

SBLP 166.99 226.79 272.66 63.27MFI 59.54 117.34 183.44 308.09Tota l 226.53 344.13 456.10 201.34

Incremental LoansOutstanding (Rs.Billion)

SBLP 46.33 56.80 45.87 (0.01)MFI 24.98 57.80 66.10 246.61Tota l 71.31 114.60 111.97 157.01

18.4 Thoug h there ma y be som e d up lica tion in the num ber of custom ers, the

follow ing nee d s to b e note d:

a) The sha re o f SBLP in te rms of c usto mers ha s d rop ped from 78.27%in 2008 to 70.72% in 2010. Eve n m ore significa ntly its sha re o foutsta nd ing loa ns ha s d rop ped from 73.71% to 59.78%.

b) The sha re of SBLP in inc rementa l loans ha s d rop ped from 64.96%to 40.96% a nd in ac tua l terms is lower in 2010 tha n in 2008.


35/65

34

c ) While the total number of customers between 2008 and 2010increased by 140.52%, the outstanding portfolio increased by201.34%. This shows tha t the a verag e size o f the loa n per borrow erha s inc rea sed b y 43.28%. This sug gests tha t the re is eithe r an

increase in the size of the average individual loan given to theborrower or is an indication of multiple lending/over borrowingresulting from more than one loan being given to the sameborrower.

18.5 The rea sons for the inc rea sing d om inanc e of the MFI Group vis--vis banklinkage need to be examined. Five possible reasons have beensuggested.a) First, it is believed MFIs have been able to achieve a deeper

reach as they tend to have a more informal approach asopposed to banks which still operate through traditionalbranches.

b) Sec ond , MFIs a re sa id to b e m ore a ggressive in sec uring businessas they use more of the local population as field workers whichgives them better access to borrowers as opposed to bankswhich still la rgely use trad itiona l sta ff.

c ) Third , the p roc ed ures used by MFIs a re sa id to be simp ler and lesstime-consuming whereas the procedures used by banks tend to

be bureauc ra tic and lab orious.d) Fourth, ba nk loa ns to SHGs ha ve a long er rep ayme nt p eriod a ndd uring tha t p eriod if SHG m em bers need loa ns, they a pp roa c hMFIs.

e) Finally, it is believed that banks find it easier to use MFIs to meetthe ir p riority-sec to r ta rge ts. This is pa rticularly true near the yearend where banks invest in securitized paper issued by MFIs tome et ta rge ts.

18.6 Given the lower cost of funds which banks enjoy, there is no reason whyba nks c anno t a c quire a larger share of the m a rket a nd thereb y providemore effec tive c om pet ition to the M FIs. This c ould result in a gene ra lred uc tion in interest rate for borrow ers.


36/65

35

18.7 Reserve Bank has rec ent ly ta ken a num ber of steps for furthe ring financ ialinclusion through mainstream financial institutions by offering a minimumof four financ ia l prod uc ts, nam ely, (a) a savings c um overdraft ac c ount,(b) a rem itta nc e p rod uc t, (c) a p ure savings produc t-ide ally a rec urring

dep osit, and (d) a gene ra l p urpose Cred it Ca rd or Kisa n Cred it Card.

18.8 In ad d ition, ba nks have be en a dvised to p ut in plac e a b oa rd -a pp rovedFinanc ial Inc lusion Pla n to be rolled out o ver the ne xt three yea rs. Theplans and the self-set targets are being closely monitored by the ReserveBank.

18.9 To fac ilitat e this p rog ra mme of financ ial inclusion, Reserve Bank ha s a lsoannounc ed the fo llow ing m ea sures:-

a) Banks are permitted to utilise the services of intermediaries toextend penetration outreach by providing financial and bankingservic es through the use o f b usiness fa c ilita to rs and businessc orrespond ents, inc luding SHGs.

b) Domestic scheduled commercial banks including Regional RuralBanks ha ve bee n p ermitted to free ly op en b ranc hes in Tier 3 toTier 6 centres with p opulation of less tha n 50,000 persons.

c ) In the North Ea ste rn Sta te s and Sikkim, do mestic sc hed uledcommercial banks are permitted to open branches in rural, semi-

urba n a nd urba n c entres.d) 2012 to 72, 825 un-banked villages which have population inexcess of 2000 persons.

These m ea sures should g ive the nec essa ry op p ortunity to banks to trea tfinancial inclusion as a viable business proposition and to increase theirpe netra tion in the microfinanc e sec tor.

18.10 We would therefore rec om me nd that bank lending to the Mic rofinancesec tor both through the SHG-Bank Linkag e p rog ramm e a nd direc tlyshould be significantly increased and this should result in a reduction inthe lend ing interest rates.

19 Priority Sec tor Sta tus19.1 Current ly all loa ns to MFIs a re c onsidered as p riority sec to r lend ing. It ha s

been suggested that there is no control on the end use of these funds


37/65

36

and that there is significant diversion of these funds from the purposesintended to other purposes. It is also suggested that in determiningpriority sec tor lend ing wha t nee ds to be c onsid ered is not the a va ilab ilityof credit but rather the availability of affordable credit. Considering the

high ra tes a t w hic h MFIs lend funds, it ha s bee n sugg ested tha t a dva nc esto MFIs should not qualify as priority sector lending.

19.2 As at 31 st March 2010, the total funds made available by banks andFina nc ial Institu tions inc lud ing SIDBI amounte d to Rs. 18,000 crores. Thisincludes the securitized portfolio of these institutions amounting to Rs.4200 crores. In the context of the total outstanding loans and advancesof a ll sc hed uled c om merc ial ba nks a t Rs.34,97,054 c rores a s a t Ma rc h 31,2010, this is not a significant amount.

19.3 How eve r, rem ova l of p riority sec tor lend ing to loa ns g iven to MFIswo uld not, in our op inion b e a dvisab le for the fo llow ing reasons:-a) If the recommendations made by us are accepted, there should

be significant reduction, both in the diversion of funds and in therates of interest.

b) Even though priority sector loans are not made available atconcessional rates, banks are under some pressure to meetta rgets of p riority sec to r lend ing. There is the refo re c om pet ition

among the banks to find MFI customers for securitisation orlend ing. This c om petition c ould d rive d ow n borrow ing c osts a ndwith the ceiling on margin gap recommended, could reduceinterest rates.

19.4 There a re existing Reserve Ba nk guide lines for lend ing to the p rioritysector. It may be necessary to revisit these guidelines in the context ofthe recommendations.

19.5 We would, therefore, rec om mend that bank ad vanc es to MFIs shouldcontinue to enjoy priority sector lending status. However, advances toMFIs which do not comply with the regulation should be denied prioritysector lending status. It may also be necessary for the Reserve Bank torevisit its existing guid elines for lend ing to the priority sec tor.


38/65


39/65


40/65

39

performance norms laid down by the Fund and measured ina c c orda nc e with internationally rec og nized me a surem ent too ls.

b) MFIs should be encouraged to issue preference capital whichcarries a coupon rate not exceeding 10% to 12% and this can be

c onsid ered as Tier II c a pita l in ac c orda nc e w ith norms app lic ab leto b anks.

21.4 We would, therefore, rec om me nd that:a) The c reation of one or more "Dom estic Soc ial Capital Funds" may

be exa mined in c onsultation with SEBI.b) MFIs should be enc ourage d to issue preferenc e c ap ital with a

c eiling o n the c oupon rate and this c an b e treated as part of Tier IIc ap ital subjec t to c ap ital ade quac y norms.

22 Monitoring of Com plianc e22.1 The suc c ess of a ny reg ulato ry fra mew ork ultima tely is d etermined by the

extent to w hic h c om p lia nc e with the reg ulations c a n be m onitored .

22.2 We believe the responsibility for compliance with the regulations willhave to be borne b y four a ge ncies as me ntioned b elow.

22.3 First, the primary responsibility for compliance must rest with the MFI itself.

It will, therefore, have to make organisational arrangements to assignresponsibility for compliance to designated individuals within theorganisation and establish systems of internal control and inspection toensure that compliance exists in practice. Allied to this, there has to be,as stated earlier, a system of levy of penalties both on the MFI and onindividual members of the management in the event of non-compliance.

22.4 Sec ond ly, (a ) Ind ustry assoc iat ions must a lso a ssum e grea te r resp onsibilityin ensuring c om p lia nc e. A p ossib le sc hem e which ma y be co nsideredwo uld be as unde r:i. The Reg ulato r will rec ognize o nly those ind ustry assoc iat ions which

have a minimum me mb ership , for exam ple, in excess of 33 1/ 3 % ofthe total number of MFIs registered with the Regulator for the


41/65

40

purpose of consultation, dialogue and information sharing topromote hea lthy and b alance d growth of the sec tor.

ii. The a ssoc ia tion will have a c od e of c ond uc t in ac c orda nc e withthe C lient Prote c tion Cod e a s stipulated b y the Reg ula tor.

iii. The a ssoc ia tion will have a n Enforce me nt Comm ittee to c hec kviolations of the Code brought to its attention by its owninsp ec tion system o r b y outside rs including the Sta te Go vernmenta nd the Reg ulato r.

iv. The a ssoc iation will d isc ipline its mem bers b y remo ving them frommembership if there is persistent violation of the Code and willpub lic ise the fa c t of rem ova l

v. The m em bers will pub licly ac knowled ge the ir me mb ership of thea ssoc ia tion in their lett er hea d s and in a ll their c om munic a tions.

b) If the above steps are effectively implemented, membership of theseassociations will be seen by the trade, borrowers and lenders as a markof confidence and removal from membership can have adverserep utational imp ac t. This c an be a ma jor dete rrent to non-co mp lianc e.

c ) There a re a lso othe r organisa tions in the trade whic h c ove r otherfunc tions like d a ta ga the ring, assist d evelop ment NGOs, et c . These c anac t a s whistle b lowe rs to h ighlight violations of the regulations or theCode of Conduct.

22.5 Third ly, b anks which lend fund s to MFIs and which purcha se sec uritisedpaper also have a role to play in compliance. Reserve Bankcommunication of November 22, 2006 to banks specifically states thatbanks, as p rinc ip a l financ iers of MFIs do no t a p pea r to b e e nga ging w iththem with regard to their systems, practices and lending policies with aview to ensuring better transparency and adherence to best practicesnor in many cases is there a review of MFI operations after sanctioningthe c red it fa c ility. In the c a se of sec uritized loans, b anks a re the o wnersof the loa ns and the MFIs a re their agent s for rec overy. They c a ntherefore be considered as responsible for the acts and defaults of theiragents and they have therefore every right to enforce compliance. Inthe case of loans, while they may not own the loans given by MFIs, aslende rs they ca n ma nda te c omp lianc e a nd ha ve the right to enforc e it.Banks also have, through their branch network, the ability to supervisethe func tioning o f MFIs a nd SHGs to w hom they lend fund s. They must


42/65

41

the refo re ac c ep t this responsibility. Ba nks should also be enc ouraged togive loa ns to MFIs and buy sec uritized pa per la rgely in the d istric ts wherethey have a branc h netwo rk so tha t c om plia nc e is ma d e p ossible.

22.6 La stly, as Regulato r, the Reserve Ba nk ha s a role to p lay.a) As at 31 st March, 2010, the top 10 MFIs owned 64.48% of the totalloan portfolio and the top 5 MFIs owned 49.93% of the total loanportfolio. Therefore, by sup ervision o f the larger MFIs which a refew in number, Reserve Bank can actively supervise a large partof the Mic rofinanc e sec tor financ ed by MFIs

b) The na ture o f th is sup ervision should be both o ff-site a nd on-site.However, given the wide geographic spread, the small value ofindividual loans and the large number of operating points, it may

not be possible to do on-site inspection of the branches of MFIs,exc ep t on sample ba sis. Sup ervision should the refo rec onc entra te on the e xistenc e a nd o p eration of the orga nisationalarrangements, the reporting systems, corporate governance etcand a review of the financial statements to ensure compliancewith reg ulatory norms. To g ive further streng th to this sup ervision,the Reserve Bank should ha ve the p ow er to remo ve the CEO a nd

/ or the directors in the event of persistent violation of theregulations quite apart from the power to deregister the MFI and

thereb y p revent it from op erating in the microfinanc e sec tor.c ) Since the ind ustry assoc ia tion is one c om ponent of thecompliance system, the Reserve Bank should also inspect theindustry associations to ensure that their compliance mechanismis func tioning.

d) Another possibility which needs to be explored is the use ofoutside specialized agencies for inspection of MFIs in place of orin ad d ition to inspec tion b y Reserve Ba nk. Suc h a genc ies exista nd if they a re used , the c ost of the se servic es c a n be rec ove redfrom MFIs.

e) If the Reserve Ba nk is to a dequa te ly disc ha rge its responsibilities toensure c om p lianc e of the NBFC-MFIs with its reg ulations, it will a lsoneed to c onside rab ly enha nc e its existing sup ervisory orga nisa tiond ea ling with NBFC-MFIs.


43/65

42

22.7 We would, therefore, recom mend that:-a) The prima ry respo nsibility for ensuring c om plianc e with the

regulations should rest with the MFI itself and it and itsma nage me nt must be pe nalized in the event of non-c om pliance

b) Industry assoc iations must ensure c om plianc e throug h theimplementation of the Code of Conduct with penalties for non-compliance.

c ) Banks also must play a pa rt in c om plianc e by surveillanc e of MFIsthrough their branches.

d) The Reserve Bank should have the responsibility for off-site andon-site supervision of MFIs but the on-site supervision may bec onfined to the la rge r MFIs and be restricted to the func tioning ofthe organisational arrangements and systems with some

supervision of branches. It should also include supervision of theindustry associations in so far as their compliance mechanism isconcerned. Reserve Bank should also explore the use of outsideag enc ies for inspe c tion.

e) The Reserve Bank should have the power to remo ve from officethe CEO a nd / or a direc tor in the event of p ersistent violation ofthe regulations quite apart from the power to deregister an MFIand prevent it from operating in the mic rofinance sec tor.

f) The Reserve Bank should c onside rably enha nc e its existing

supervisory organisation d ea ling w ith NBFC-MFIs.

23 Money lenders Ac ts23.1 There a re Ac ts in several sta tes governing money lend ing b ut the se w ere

ena c ted seve ra l d ec ad es ago. They d o not, therefore, sp ec ifica llyexemp t NBFCs thoug h they d o exemp t b anks, sta tuto ry c orpo ra tions, co -op eratives and financ ial institutions.

23.2 As a Tec hnica l Com mittee of the Reserve Ba nk has p ointed out, d espitethe leg isla tion, a large num ber of mo ney lend ers op erate without lic enseand eve n the reg istered mo neylenders c ha rge interest ra tes muc h highe rthan permitted by the law, apart from not complying with otherp rov isions. The rep ort sta tes tha t Signs of e ffec tive enforc em ent of theleg isla tion a re a bsent .


44/65

43

23.3 The Tec hnica l Com mitte e sta tes tha t in ma ny internat iona l jurisd ict ions,for exam ple, Hong Kong, Singa pore, Lesotho , there a re spec ificp rov isions in the law for exem ption to c erta in entities. The Tec hnica lCommittee has recommended that since NBFCs are already regulated

by the Reserve Bank, they should also be exempted from the provisionsof the mo ney lend ing a c ts. We endo rse tha t rec om me nda tion.

23.4 We, therefore, recom mend that NBFC-MFIs should be exem pted from theprovisions of the Money-Lending Acts, especially as we arerecommending interest margin caps and increased regulation.

24 The Mic ro Financ e (Develop ment and Reg ulation) Bill 201024.1 The Ce ntra l Go vernment ha s d ra fted a 'Mic ro Fina nc e (Develop me nt

and Regulation) Act 2010 which will apply to all microfinanceorganisations other than:a) banks;b) co-operative societies engaged primarily in agricultural

operations or industrial activity or purchase or sale of any goodsa nd suc h o ther ac tivities;

c ) NBFCs other tha n lice nsed und er Sec tion 25 of the Com p aniesAct, 1956;

d) co-operative societies not accepting deposits from anybody

except from its members having voting rights or from thoseme mb ers who will a c quire vo ting rights a fter a stipulated p eriod oftheir making deposits as per the law applicable to such co-operative societies.

24.2 The p rop osed Ac t p rovide s tha t the Centra l Go vernment will c onstitute aMicro Finance Development Council to advise NABARD on theformulation of policies, schemes and other measures required in theinterest of o rderly growth a nd deve lop me nt of m icrofinanc e servic es.

24.3 The p rop osed Ac t a lso p rovide s tha t a mic rofinanc e o rga nisa tion which isproviding thrift services or which intends to commence the business ofproviding thrift services should be registered with NABARD.


45/65

44

24.4 NABARD has the responsibility under the proposed Act to promote andensure orderly growth of microfinance services provided by theorganisations covered by the Act. In furtherance of this responsibility ithas the power to issue directions to such organisations and to carry out

inspec tion o f suc h o rga nisa tions.

24.5 In our op inion, the follow ing ma tters nee d c onsideration:a) We are in agreement with the purpose of the proposed Act "to

provide for promotion, development and regulation of the microfinanc e o rga nisa tions in rura l and urba n a rea s." In th is c ontext, it isnecessary to note, as we have earlier pointed out, that it isestimated that 58% of the outstanding loan portfolio in the microfina nc e sec tor is ow ned b y the SHG- Ba nk linkage m od el and 34%

of the portfolio is owned by the NBFC-MFIs. Both banks and NBFCsare outside the scope of the proposed Act, and are infactreg ulate d by Reserve Bank.

b) Therefore, the o rganisa tions whic h a re no t regulate d by theReserve Bank account for an estimated 8% of the outstandingmic ro financ e loa n p ortfolio. Since c o-op erative soc ieties whic hha ve voting rights to me mb ers a re e xc luded from the p rovisions ofthe p rop osed Ac t, this pe rc enta ge ma y be e ven low er.

c ) These resid ua l entities will ha ve a wide va riety of c onstitutiona l

forms, namely, trusts, societies, partnership, sole proprietorship,etc., each governed in some form by different regulatorya utho rities. They wo uld a lso rep resent a large num ber of e ntities,with many entities being of very small size.

d) If these entities are not regulated, a regulatory gap would becreated and therefore we support the proposal in the proposedAc t tha t the se entities be reg ula ted . In o rder tha t this reg ula tion isin place, there should be a specific provision in the proposed Actfor such entities to be registered with the regulator. Howevergiven the large number of entities, we would suggest registrationshould be made mandatory only for entities which have anoutstanding micro finance loan portfolio of Rs.10 crore or more. Incalculating this limi

malegam committee report

Documents