What is the macroeconomic implication of an SKS Microfinance going public? Simply, that after the initial public offering, or IPO, of a microfinance institution (MFI), microfinance becomes an asset class. Whether it will stay as a separate asset class or become part of a much larger sector of emerging financial services depends on the policy framework within which it will be made to operate. It is this that should determine the need, nature and network of regulation for this sector.
Instead, the need for regulations is being triggered by the tamasha at SKS that has suddenly made the government realize that the strategy of MFIs has shifted— from poverty eradication to profiting from the poor. Hence, the hurried move for regulation.
And if the reasons to regulate are misplaced, the proposal that Nabard, or the National Bank for Agriculture and Rural Development, be the regulator is even more flawed. It is a participant in the microfinance sector, leading the self-help group (SHG)-bank linkage mode of delivery in this sector with Nabard financing and refinancing a whole host of SHGs in the same space as MFIs.
How can a participant be a regulator? It is like BSNL, or Bharat Sanchar Nigam Ltd, becoming the regulator for the telecom sector. Combining the role of service provider and regulator is very regressive governance, because it could lead to serious conflict of interest. That apart, Nabard’s performance as a supervisor, for regional rural banks and state finance corporations, is obvious from the state these lending institutions are in.
These policy moves don’t consider the fundamentals of this business. Before deciding who will regulate, it must be decided what is to be regulated. Is it MFIs or is it microfinance lending that needs to be regulated? The two are vastly different. At the moment, even though there is no specific microfinance regulation, the non-banking financial company regime does apply to MFIs.
If there has to be a specific regulatory framework for the MFI sector, the nature and design of regulations will depend on how microfinance lending is seen by policymakers. If the aim is to get MFIs to scale up overtime into full-fledged banks, regulation will have to be transitional. Once the evolution is complete, MFIs will fall within the regulatory ambit of the Reserve Bank of India for banking services—an ambit that is comprehensive and robust.
On the other hand, if the idea is that an MFI has to remain a separate asset class, then the quality and quantity of regulation has to be different. In such a situation, what MFIs require are not prudential regulations. Those are needed only if MFIs accept retail consumer deposits or are large enough to pose a threat to the financial stability of other institutions.
Instead, the emphasis then has to be on non-prudential regulations which focus on transparency and disclosure and may be largely self-executing. Non-prudential measures include disclosing effective interest rates and screening out unsuitable owners and managers.
It will be not just myopic, but also detrimental if the regulatory edifice is built around the issue of high interest rates, as it seems to be at the moment. The interest rate is only one relevant component of a credit contract—others include the repayment schedule, the provision of collateral, the choice between cash and kind, the specification of simple or compound interest, and so on. Besides, there is conclusive cross-country evidence that low interest rate ceilings lead to the rationing of credit—to the benefit of those better off and more powerful.
The basic question, then, is whether it is possible to support the growth of the financial sector so that institutions serving less endowed households and small enterprises can charge interest rates that are affordable and sustainable. If interest rates remain a concern, a better way to go about is liberalizing them.
We have to recognize that a complex set of measures is actually required to lower market-based interest rates. Interest rates are interconnected with many other measures. These include issues of competition (market entry and regulations), access to and cost of funds (financial market development), the costs of poor communications infrastructure and efficiency at the institutional level. This then calls for reform rather than regulation.
The ideal way to go bring about a structural change is to treat microfinance as a business offering—a vertical, in management parlance—at any financial institution and then to supervise microfinance as an emerging asset class. This means allowing the full range of financial institutions—scheduled banks, insurance companies—to offer microfinance services, thereby treating microfinance portfolios as an asset class (as regulators would, say, retail loans) in terms of vetting products, categorizing risk and laying down reserves and provisioning requirements.
All said and done, as Adam Smith wrote in The Wealth of Nations: “Money makes money. When you have got a little, it is often easy to get more. The great difficulty is to get that little.” MFIs are giving that little—and that should be helped not hindered.
Haseeb A. Drabu is former chairman and chief executive of Jammu and Kashmir Bank. He writes on monetary and macroeconomic matters from the perspective of policy and practice. Comment at email@example.com
To read Haseeb A. Drabu’s previous articles, go to www.livemint.com/methodandmanner