The microfinance sentinels
The ability of an SRO to exercise regulatory authority does not necessarily derive from a grant of authority from the government
Policymakers today generally recognize that sound and stable long-term economic growth can best be supported by regulatory policies that minimize interference with the functioning of the market. Financial sector reforms in developing economies are thus increasingly oriented towards mechanisms to induce effective market discipline, and towards regulatory/supervisory regimes that are market-friendly or that mimic the market in driving agent decisions through incentives to honest and prudent behaviour," said Biagio Bossone and Larry Promisel of World Bank in their paper on Self-regulation in developing economies.
A self-regulatory organization (SRO) is one that exercises some degree of regulatory authority over an industry or profession. The regulatory authority could be applied in addition to some form of government regulation, or it could fill the vacuum of an absence of government oversight and regulation. The ability of an SRO to exercise regulatory authority does not necessarily derive from a grant of authority from the government.
India has the largest microfinance industry in the world. The 32 million micro-borrower accounts are three times the number at regional rural banks, significantly higher than those held by commercial banks, and constitute 24% of total small loan accounts. Its contribution to financial inclusion continues to rival the rural banking system, cementing its position as a significant component of the financial system in the country.
In 1998, the National Bank for Agriculture and Rural Development (Nabard) set up a task force on Supportive Policy and Regulatory Framework for Microfinance, which found that microfinance institutions (MFIs) were an important vehicles for delivery of credit to the self-employed, particularly women, in rural and semi-urban areas. It suggested setting up a special cell within the Reserve Bank of India (RBI) to liaise with Nabard and MFIs to augment the flow of credit to this sector. The task force recognized the need for a mechanism of self-regulation for MFIs and for encouraging the promotion of SROs. It recommended that the major functions of SROs would be: (i) overseeing functioning of MFIs as base-level regulators, (ii) undertaking registration, (iii) evolving a proper systems for maintenance of accounts and reporting, (iv) setting performance standards, (v) conducting inspections, (vi) undertaking training, and (vii) representing MFIs in various forums. 2 December 2011 was a proverbial red letter day for Indian microfinance, with RBI creating a new category of non-banking financial companies (NBFCs) called NBFC-MFIs. The notification also provided for a forward-looking agenda of regulations in line with the recommendations of a committee headed by Y.H. Malegam. In the specific context of SROs, to quote Malegam on the four pillars of compliance, “The second pillar is an association. If one-third of MFIs become members of an association, they (RBI) will recognize it. The association will have its own code of conduct. If discipline is not observed, the association, which will be something like an SRO/s...can remove that member."
For giving effect to the recommendations of the Malegam committee on industry SROs, RBI issued the necessary guidelines on 26 November 2013. The guidelines represent a major step forward in the creation of a layered regulatory architecture for the microfinance industry. This emerging architecture has far-reaching ramifications for the healthy development of the industry and its ability to get fully embedded into the national financial system. The industry SROs acting practically as the designated delegatees of the apex financial services regulator, namely RBI, will carry a large burden. This burden will also be a burden of faith; the faith which both RBI and the industry would have reposed on them. Established in December 2009, constitutionally, structurally, and functionally, Micro Finance Institutions Network (MFIN) has been acting as a de facto SRO for its members. Its 43 members, all NBFC-MFIs, have a client outreach of over 25 million low-income borrowers with a loan outstanding of approximately ₹ 23,000 crore. The MFIN Code of Conduct, almost a precursor to RBI guidelines and regulations for the industry, was released in April 2010. It covered a range of areas such as governance, client protection, staff behaviour, resolution of complaints, promoting transparency and whistleblowing. It also provided for setting up an ombudsman for member-MFIs for fair and transparent adjudication of disputes and client protection. For ensuring adherence to the code, a self-certification process and an enforcement committee were put in place. The measures taken, while far from perfect, have led to a distinct improvement in industry practices and creation of an ethos of responsible lending.
Another large initiative taken by MFIN has been the development of a credit bureau ecosystem for the microfinance sector. Over the past two years, MFIN’s efforts have resulted in 100% adoption of the use of Credit Bureau checks by member-MFIs. In this context, it is noteworthy that an industry which did not have any credit bureau till 2009, had, as of 30 September, contributed over 100 million loan records to the credit bureaus. And every month, about 2 million credit queries are made.
Self-regulation will boost the overall franchise value of the microfinance sector and reduce costs associated with limited trust and asymmetric information. The grant of formal SRO status to MFIN will improve the governance process and redressal mechanism in the sector. The SRO guidelines provide the much-needed impetus to the goal of inclusive growth for the vast unserved and underserved segments of the population by facilitating access to inclusive financial services in a responsible and transparent manner.
With its members representing over 80% of the industry and the experience gained over the past three years, MFIN is arguably the most appropriate organization for grant of SRO status by RBI. In many ways this will merely represent a shift from a de facto to a de jure position.
Alok Prasad is CEO of MFIN; Vipin Sharma is CEO of Access Development Services
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