Ramesh Pathania/Mint
Ramesh Pathania/Mint

MFI rules need more thought; else, they can go wrong

MFIN's Alok Prasad talks about how the future of microfinance may evolve

The microfinance industry has witnessed many changes since the 2010 crisis. Recently, the Reserve Bank of India (RBI) eased some lending norms for microfinance institutions (MFIs), which will mean enhanced access to credit for customers. Also, the government has proposed that the Mudra Bank (Micro Units Development Refinance Agency Bank) will regulate MFIs. Alok Prasad, chief executive officer, Microfinance Institutions Network (MFIN), a self-regulatory organization for non-banking finance company (NBFC) MFIs, talks about regulatory challenges in the industry and how the future of microfinance may evolve. Edited excerpts:

In its previous policy review, RBI eased lending norms for MFIs. Was the industry expecting such a development?

This is something the industry had sought from RBI. Fortunately, the central bank is fairly open in conversations, and likes constructive dialogue on regulatory and policy issues. The issue wasn’t just about raising the limit in terms of the loan amount or income ceilings. The matter had to be seen in the wider context of the operating framework mandated by RBI after the 2010 crisis. The crisis triggered a full review of the regulatory policies applicable to MFIs. The Malegam committee’s recommendations in 2011 became the basis of the framework that RBI put down for MFIs. In December 2011, it came out with a detailed set of regulations and also created a new category called NBFC-MFIs. So, dating back to 2010-11, and taking everything together—the crisis, RBI’s and the microfinance industry’s response to it, and the industry’s progression till 2014-15—there was a need for a thorough review of the rules framed in 2011.

It must also be pointed out that the operating rules, for the most part, were based on 2009 data. Since then, the financial landscape, the industry and the macroeconomic environment have changed. While the industry welcomes the changes, this should be seen as work in progress.

This is the initial step. The macro-economic environment is changing very rapidly. The Mudra Bank (refinancing agency for micro units) initiative is going to be transformational. If done right, its impact on the industry and on how unfunded categories are able to get linked to the financial system will be big.

Earlier a person with 50,000 loan could avail fresh loan. This limit has been increased to 1 lakh. Will it not increase the risk of non-repayment?

In any business, you carry certain operating risks. In the lending business, you are subjected to a range of financial risks; it’s about how well you manage them. Whatever be the loan amount, the lender is exposing itself to the full range of credit risks. As a lender, one’s job is to ensure that the risks are well understood and that there is a framework to manage them. The nature of risks may change as loan amounts and customer segments change. But this does not necessarily imply that risks are greater as lending limits go up. It is for the lender to asses the different kinds of risks being taken as loan amounts go up and borrower segments expand.

As a part of running your business, you need to put in place appropriate processes and controls as are necessary to manage risks.

Some credit score bureaus say they are providing credit data to MFIs as well. Is that helpful?

The fact of the matter is that currently, for microfinance clients, there isn’t a robust and empirically established scoring system. Some modelling has been happening but it is nowhere as developed and sophisticated as one would find in the US or other developed economies. The credit bureaus are providing data on how many loans a potential borrower has taken, who are the lenders, what is the current outstanding amount and what is the repayment record. These 4-5 specific data points about a loan applicant can be seen in a bureau report. But as such, there isn’t any score. Based on these data points, it is the job of the MFI to take its own decision on whether to give a loan or not. Essentially, the report can be used to ensure that the MFI is not violating the lending norms set by RBI. Credit scores are work in progress. For MFI clients, it is still a long journey.

There are two self-regulatory organizations for MFIs—MFIN and Sa-Dhan—and there is some overlapping in terms of membership. How will this pan out?

The existing framework for a self-regulatory organization (SRO) is an outcome of the Malegam committee’s report, which provided for recognition of more than one SRO. This is the recommendation that RBI has now implemented.

The core issue is whether two SROs can create a situation of SRO arbitrage. Say, one SRO is trying to establish higher standards and tighter disciplines. With no compulsion to stay with it, member organizations (MFIs) may walk away to the other SRO, which has lower standards. A situation of SRO arbitrage is something we will have to be watchful of. We will have to keep flagging it to RBI as a part of our continuing dialogue. In parallel, the two associations will have to work towards a high level of co-ordination to ensure that the elements of arbitrage are either non-existent or reduced to a level where it is no longer meaningful for any MFI to make the jump. Is it going to be easy? My sense is no.

Even globally, there is hardly any good example of a successful SRO in the financial services sector. Regulating financial institutions is complicated and often intertwined with other economic issues. Even the best of regulators have struggled with this challenge.

Having an SRO that is non-statutory in nature with a voluntary compliance framework, the challenges are even greater. And then to have two SROs, introduces another level of complexity. So, it is not going to be easy.

Many pieces need to be thought through. RBI and the two existing SROs need to come together and engage in far deeper dialogue than has been the case till now. Else, the SRO architecture may, over time, turn out to be a failed ‘experiment’.

With the government planning to have Mudra Bank as the nodal agency for all MFIs, won’t SROs become irrelevant?

This is the third level of complexity. From a situation where you have one regulator and two SROs, we can get to a stage where there is an altogether new regulator.

If finally there is a new regulator, it will take its own decision on whether it wants SROs or not. There could even be a situation where there are two regulators—one regulating the NBFC-MFIs and the other regulating NGO-MFIs—and two SROs.

The SRO framework, as a subset of the overall regulatory architecture for the industry, is an emerging phenomenon. It has to be thought through and it calls for much deeper levels of consultation and dialogue. Otherwise, it could go wrong, and go wrong badly.

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