WHEN MORE MONEY IS NOT THE ANSWER.
An Analysis of India’s Microfinance Crisis and the Need for Comprehensive Regulation. Meena Aharam International Banking Regulation, Spring 2011
Differentiating the Innovative Features of Microcredit
Inherent Challenges of Microcredit
Background to the Crisis
Existing Regulatory Framework
Commercialization of MFIs – The Case of SKS Microfinance
Implementation of Andhra Pradesh Ordinance and the Collapse of the Microfinance Bubble
Deficiencies of the Proposed 2007 Bill
Scope should include all operating MFIs
MFIs should be exempt from interest rate caps in order to operate effectively
NABARD would face conflicting interests as both a service provider and industry regulator
Uniform prudential requirements should be applied across all microfinance organizations
Looking forward to the 2010 Revision of the MFI Bill
The practice of lending and making loans dates back thousands of years, from rudimentary bartering systems and more modernly to capital markets to be accessed from commercial banks1. At its earliest conception, lending was perceived to be a charitable act of helping a neighbor by temporarily providing something that they were not otherwise able to procure. To profit off of this act was deemed as usury and immoral as the lender was considered parasitic on the borrower2. Lending combined with capitalism resulted in the dramatic growth of the banking industry. The practice has created a wealth of
opportunities, such as creating money by lending out deposits to companies and individuals that would invest into their futures. In addition to the creation of opportunities, lending is a highly lucrative practice for the banking industry – which at times has provided poor incentives of deregulation in a highly volatile industry. Perhaps as a return back to the original concept of charitable lending, microfinancing has been devised as a tool to reach out to the poor who would be otherwise excluded from mainstream loans. However, in order for microfinancing to be sustainable the desire to assist the poorest communities must be balanced with profitability, responsible lending, and the development of systems to encourage repayment. Another danger that plagues the microfinance industry is the greed that often accompanies targeting a vulnerable population such as the poor. This note will examine the microcredit crisis that occurred in Andhra Pradesh, India; specifically how the lack of regulatory framework and
Yaron Brook, The Morality of Moneylending: A Short History, The Objective Standard, Vol. 2, No. 3 (Fall 2007). Available at: http://www.theobjectivestandard.com/issues/2007-fall/morality-ofmoneylending.asp Id. (Describing Aristotle’s views in his first book on Politics and his argument for why charging interest on money is considered immoral.)
php?option=com_content&task=view&id=26&Itemid=175 Defining the scope of microfinance. and compare international regulatory schemes.php?option=com_content&task=view&id=329&Itemid=363 [hereinafter “Yonus Biography”] (Yonus is a Bengali economics professor who in 1983 founded Grameen Bank.35 million borrowers. His
.predatory lending led to financial crisis. http://www. and microinsurance4. microfinancing provides benefits to poor women allowing them to be more independent and productive members of their communities 3 . and finally make recommendations on how India can adopt international microfinance regulatory principles into the bill so that a future crisis may be averted.grameeninfo.org/index. Examples of financial services are micro-lending for those with no collateral.rc/1.
Introduction to Microfinance Microfinancing is an umbrella that covers a multitude of financial services that are
provided on a small or “micro” scale to poor and underprivileged communities.9183/ [hereinafter “microfinance gateway FAQ”] See http://www. and micro-insurance policies that would allow the poor access to health insurance and life insurance policies. http://www.org/p/site/m/template.
Grameen Bank states that of the 8.grameeninfo. this note will examine the proposed Micro Finance Development and Regulation Bill that was presented in 2007 to India’s legislative body. The basic concept of
microfinancing is to provide basic financial services to the poor who have little or no collateral in an effort to allow them to break the cycle of poverty.
I.26. 97% are women. In examining the India microcredit crisis. The microfinance revolution has been credited to Mohammed Yonus (Yonus) who recently won the Nobel Peace Prize in 2006 for his efforts with the Grameen Foundation5.microfinancegateway.
particular. microsaving. Included under
microfinancing are: microcredit.org/index.
The U.rc/1.cgap.org/index.php?option=com_content&task=view&id=41&Itemid=90 Estimation from Consultative Group to Assist the Poor (CGAP).org/p/site/c/template. See http://www.2747/
10 11 9 8 7 6
Collateral in a most basic sense gives a lender a right to an asset until repayment is complete.11.grameeninfo.grameeninfo. As a result. CGAP was authorized by and is an offshoot of the World Bank. 2) it creates an incentive for borrowers to re-pay11. General Assembly Res. Microcredit has addressed the
work with Grameen and in growing microcredit to numerous countries has won him countless awards. Differentiating the Innovative Features of Microcredit
Microcredit is a subcategory of microfinance that provides small-scale loans to persons who would otherwise not qualify for a commercial loan due to lack of collateral10.
Borrower incentive to repay is to prevent the loss of collateral which may be forfeited to the bank upon default. Collateral in normal commercial loans is essential because it: 1) indicates to the bank the customer’s ability to re-pay.
.cgap.1792/ CGAP Key Principles of Microfinance available at http://www. numerous microfinancing institutions (MFIs) have been established all over the world reaching over 152 million clients8. 52/194 (Dec. In conjunction with loaning money to poor individuals. 1997).org/index.Yonus has declared that microcredit should be considered a human right from which the poor should be given priority6.) See http://www. see http://www. officially vocalized support for the use of microcredit in order combat poverty and encourages other NGOs to provide microcredit services7.9. and 3) it protects the bank from loss in the event of customer default. A.org/p/site/c/template.php?option=com_content&task=view&id=28&Itemid=108 [hereinafter Grameen credit features] U.N.rc/1. CGAP and Grameen have emphasized the importance of teaching clients how to save while using money in a productive manner9.N.
These approaches have resulted in widely successful loan repayment percentages near 97%14. microcredit views the asset to be a person’s inherent potential to productively use the money to grow crops or make other goods that may be sold12. microcredit has created a powerful incentive system for borrowers by relying on “social lending” in combination with access to future loans. A/53/223 (Aug. First. available at
15 14 13
. U. delivered to the General Assembly. then future loans will not be made to the entire community. and the participatory nature of many micro-lending schemes15. available at http://www. This creates a powerful social responsibility among village members who know that they may jeopardize not only their own possibilities for future loans.N. January 2011 available at http://www. If loans are made to community members who miss loan repayments. Role of Microcredit in the Eradication of Poverty. rather than valuing a loan based on an asset such as a house.first two necessities for collateral with innovative solutions.org/index. but also the future of the entire community13. Social lending is accomplished by considering an entire village as a re-payment group.) Reported by Grameen Bank. disciplined and short repayment requirements. ¶¶ 11-12.php?option=com_content&task=view&id=42&Itemid=92 [hereinafter Grameen Credit Delivery] (Describing the methodology of Grameen managers developing a system of trust amongst villagers.grameen-info.php?option=com_content&task=view&id=27&Itemid=176 Grameen Bank: Credit Delivery System. This concept is comparable to a student loan which is not secured to customer assets and instead repayment is based on potential future earning power.php?option=com_content&task=view&id=26&Itemid=175 The Secretary-General. Loan amounts rarely exceed the equivalent of USD
Is Grameen Different.org/index. Doc.grameeninfo. 10 1998).org/index. Grameen Bank at a Glance. Additional factors that contribute to high levels of repayment include: small loan amounts.grameeninfo. Managers are assigned to only one village and work closely with eligible clients. January 2011 see http://www. Second.
Microfinance for Microenterprises. Discipline is a key component to the system and is instilled by community managers who develop relationships with villagers while encouraging repayment. Evaluation Study Series. has pioneered a system where a given community’s ability to receive more loans is affected by current citizens outstanding loan obligations. Ananthi S. and continued development. Another popular method was established by the National Bank for Agriculture and Rural Development (NABARD) based in India.9. saving. which links self-help groups18 to commercial banks based on capital that has been collectively saved by the group19.
Self-Help Groups (SHGs) are community pooling of capital in order to secure a loan that will be invested into community microenterprises. supra note 7.$1000. This
concept was introduced by Kiva as “crowd source capital” and harnesses the Internet to bring together people from all over the world. http://www.C. An Impact Evaluation Study of Self Help Groups (2006). Badatya. This system has been widely used in India and has expanded the microcredit operations particularly in the state of Andhra Pradesh.30422/48.N. “Crowd source capital” allow private
http://www.pdf [hereinafter “Evaluation Study of SHGs”]
. Community pressure has been created in various ways. K. for instance.org/documents/ga/docs/53/plenary/a53-223.microfinancegateway. The close participatory and community nature of microlending has been credited with providing support for borrowers as well as the aforementioned community pressure to re-pay.org/gm/document-1. and is the most common way for MFIs to reach clients in India. and often are made for less than $100 depending on the needs ability of the customer16. NBARD. Another notable microcredit approach has been person-person lending. Grameen.un. Report on Microcredit”]
16 17 18
Is Grameen Different. These small loans require weekly payments and usually require full repayment within a year17.htm [hereinafter “U. This system has been widely successful since it’s introduction in India. Id. BB Wadavi.
Kiva: Facts. and charge interest to cover administrative costs. http://www. supra note 10. Challenges that threaten the sustainability of an MFI include high risk of loan default and dis-economies of scale.org/about/facts How Kiva Works. (Comparing income-generating approach to minimalist approach. B.org to select potential borrowers.
20 21 22 23
Investors may browse websites such as Kiva.individuals to make small loans (usually between $25-$300) to entrepreneurs of their choice20. people from around the world charitably contribute in a way that empowers the poor to develop financial responsibility while creating a better future. This approach boasts a repayment percentage of 98%21 with repaid loans often resulting in reinvestment in a new entrepreneur. Report on Microcredit. The counter-argument to the minimalist approach is that there are other government programs that are available for the poor to access funds to pay for necessary costs such as medical bills. however critics of this approach argue that the poor should be given access to funds for all purposes23.org/about/how
U. Institutions such as Kiva are able to partner with existing MFIs. household expenses etc…)
.kiva. The idea is to “pay it forward” and loans are not made with the intention of making a profit. MFIs must create systems that issue loans efficiently.kiva. Rather.N. funerals. Inherent Challenges of Microcredit
Despite successes and affirmations that microcredit is a powerful tool to combat poverty. which allows their lenders to disburse funds to loan requests22. To combat these challenges. at ¶ 18. encourage re-payment. http://www. it is important to consider the sustainability of lenders in evaluating microcredit effectiveness. In an effort to create a sustainable organization MFIs have taken various approaches such as loan usage limitations and risk-adjusted interest rates. The most common loan usage limitation requires borrowers to use loans for income-generating activities in order to encourage repayment.
yellow. India takes aim at abuse of innovative microcredit model. Nov. and the Red Zone consists of IRPs above 15 percentage points. Available at http://www. Recently.themix. Red Zone MFI’s are also characterized by Yonus to be “commercial enterprises whose main objective appears to be earning large profits for shareholders or other investors”. Operating costs of MFIs are often quite high due to the administrative burdens of providing small loans as opposed to large loans. supra note 8. 26. supra note 12. Microfinance Information Exchange (March 2010). Yellow Zone consists of IRPs below 15 percentage points. at 1. which
CGAP Key Principles of Microfinance. Washington Post. supra note 16. These practices. Rama Lakshmi. and red zones26. Yonus describes the Green Zone to be “poverty focused” microcredit programs while the Red Zone27 signifies “profitmaximizing” MFIs. Loan sharks would fall into this category of lending. Yonus contends that it is important for clients to meet explicit criteria in order to preserve MFI resources. (Discussing how interest rate ceilings are harmful to poor people’s ability to borrow due to unsustainable costs incurred by MFIs.) Interest rate premium is defined as the difference between the rates charged by the MFI to the borrower and the cost of funds at the market rate paid by the MFI. Yonus addressed the issue of interest rate premiums 25 by
categorizing premiums into green. 2010. MFIs should evaluate the purpose of their operation while engaging in efficient lending to cut down on operating costs28. (Describing the cause of dozens of rural farmer suicides that are attributed to the shame and harassment of non-payment. (The Green Zone consists of interest rate premiums (IRP) below 10 percentage points. Grameen Credit Delivery System.org/publications/mix-microfinance-world/2010/03/analyzing-microcreditinterest-rates-review-methodology. Adrian Gonzalez.
II. Analyzing Microcredit Interest Rates.[hereinafter “Analyzing Microcredit Interest Rates”] Analyzing Microcredit Interest Rates.)
29 28 27 26 25 24
. the Indian state of Andhra Pradesh issued an ordinance aimed
at protecting women from exploitative microfinance practices29.) Id.The risk-adjusted interest approach is also a widely used tool that is reinforced by CGAP as essential to continue the long-term sustainability of MFIs to support the needs of borrowers 24 .
INDIA’S MICROFINANCE CRISIS In October of 2010. Using this evaluation method it can be concluded that although rate ceilings should not be imposed. at ¶ 7.
Given the staggering number of
Id. These citizens survive on USD $1. NABARD seeks feedback on Microfinance Regulation draft. Center for Global Development (November 2010).php. Background to the Crisis
India historically carries an impoverished class of citizens that currently accounts for 41% of its one billion citizens34. is now over 50%. 22. (Feb.worldbank. are being blamed for more than 50 suicides30.microfinancefocus.
. Grameen Credit Delivery System.include predatory lending practices and harassment for non-payment. this ordinance is being blamed for the microfinance crisis that is currently gripping India. As a result default on loans. India is currently considering regulatory legislation to re-instill confidence in MFIs companies and to ensure that future lending abuses do not occur33. http://www. which was less than 2% prior to the ordinance. Backgrounder on India’s Microfinance Crisis.
David Roodman. The arguable cause rests is that the order to stop disbursing new loans has killed the important incentive for consumers to continue with required weekly repayments32. http://go.cgdev. Despite the best intentions of protecting impoverished consumers.com/news/2010/02/22/nabard-seeks-feedback-onmicrofinance-regulation-draft/ Revised Poverty Estimates. This aspect of the Grameen plan was considered crucial part of the high repayment rates. Weekly payments of loans are required under the Grameen scheme for customers to receive future funds. What does it Mean for India?.org/CG39MFTA90
35 34 33 32
Id. Microfinance Focus. available at http://blogs. A. 2010).org/open_book/2010/11/qa-on-indiasmicrofinance-crisis.25 a day and often live in areas where there is little to no infrastructure35. supra note 12. The ordinance requires all MFIs to cease lending and collecting on debts until they register with local officials31.
U. the World Bank estimates that 87% of India’s poor does not have access to formal credit sources.php.org/open_book/2010/11/qa-on-indiasmicrofinance-crisis. 2010). 5 B. http://www. at 15.9.cgap. Backgrounder on India’s Microfinance Crisis. Center for Global Development (November 2010). small NGO MFIs began flourishing in India due to lesser restrictions and oversight of smaller entities38.
. & Mgmt. The concept of microcredit and empowering the poor in India originally began in 1992 with the NABARD approach called the Self Help Group-Bank Linkage (SHG) program which encouraged communities to begin saving what they could so that they could collectively apply for loans through commercial banks37.org/gm/document-1. after changing to a Non-Bank Finance Company (NBFC) within 7 years this
As of 2008. However. NGO MFIs found difficulties in raising capital due to restrictions on deposit taking.Y. Rev. Stephen Rasmussen. CGAP Focus Note No. available at http://blogs. & Daniel Rozas. The Role of Private Sector Investment in International Microfinance and Implications of Domestic Regulatory Environments. supra note 13. Xavier Reille. Int’l L. This initiative proved successful especially at organizing women who were otherwise unable to contribute.
Evaluation Study of Self Help Groups. William Langer.000 borrowers by 200339.cgdev. 65 (Sept. 1. India began following a similar formula of providing microcredit through group lending. [hereinafter “SKS IPO”] David Roodman.pdf.persons that would be ideal candidates for microcredit loans.47613/FN65_Rev. available at. Companies such as Swayam Krushi Sangam (SKS) Microfinance were founded as NGOs in the late nineties initially reaching out to a modest 11. India Microfinance Goes Public: The SKS Initial Public Offering. 53 (2008). The goal of these loans was to allow the community to create microenterprises that would further develop and benefit the village.
However. Greg Chen. Informal credit sources often charge interest rates of 48%-120% while MFIs charge interest rates between 15%-30%. Consequently. there can be little surprise at the growth rate of MFIs in India36. Following the success experienced by Grameen Bank in Bangladesh.
42 43 41
Governed by the Societies Registration Act (1860) Governed by the Indian Trusts Act (1882)
.8 million borrowers at the end of 2010. Understanding India’s Microcredit Crisis. The most common forms of MFIs in India are: NGOs 42 .com/news/2010/01/10/microfinance-in-india-twin-steps-towardsself-regulation-3/ David Rooman. Societies and Trusts 43 . AID Watch (November 2010). and
A bubble is defined as “divergence of asset valuation with its true value. The minimum regulations in place oversaw the various forms of entities that may operate as an MFI in India. 10 2010). available at http://aidwatchers.” In India. This fast growth is blamed for creating a microfinance bubble in India that inevitably crashed in late 201040. Existing Regulatory Framework
India’s lack of specific microfinance regulations was a major contributing factor to the 2010 crisis.microfinancefocus. Vijay Mahajan & P N Vasudevan. non-profit MFIs are not subject to regulations so long as they do not engage in depositing taking. Microfinance Focus (Jan. Thus far. success was measured on by the number of people serviced by microcredit rather than focusing on credit exposure and the repayment capability of loan recipients. B. MFIs have taken both not for profit and for-profit forms with the biggest different between them being that for-profit models are regulated by the Reserve Bank of India (RBI) and are allowed to take deposits. India’s growth and the resulting crisis can be contrasted from the success in Bangladesh for several factors such as a lack of regulation and the commercialization of the microcredit sector41. http://www.number swelled to over 5. Microfinance in India: Twin Steps Towards Regulation.
.nabard. at 57. etc. Langer.org/nabardrolefunct/nabardrole&functions. supra note 36.
The most successful forms of MFIs in India are: Section 25
Companies44. they are now required to register with the RBI and non-deposit taking NBFCs maintain a capital adequacy ratio of 12%.Cooperative Banks. State Governments. supra note 36. Langer. training of personnel. and rural lending banks. The
These special companies are able to operate as LLCs but are treated as non-profits therefore foregoing onerous regulations. and Non-Banking Finance Companies (NBFCs)45. at 64-5. supra note 14. Section 25 of the Companies Act governs them. nor interest rate controls to ensure that usury interest rates are not charged49. loan limitations. http://www. Available at.”
NABARD is credited with creating the
innovative SHG linkage-system providing loans through MFIs48. Apex development bank signifies the bank taking on a coordination role between the federal government. NABARD additionally has been tasked with “improving absorptive capacity of the credit delivery system. and the RBI. http://www. The National Bank for Agriculture and Rural Development (NABARD) was created in 1982 as an apex development bank46 and set to take on a coordinative role between the Indian Government. etc…).asp
47 48 49 46 45
See generally.asp Evaluation Study of SHGs. formulation of rehabilitation schemes. However. supra note 36. no uniform oversight exists to provide prudential guidance (capital adequacy. including monitoring. state governments.org/introduction. Until recently. restructuring of credit institutions. at 58.nabard. The only areas that the RBI does provide specific oversight are deposit-taking institutes. Beyond regulations governing the structure of entities that may operate as MFIs. NBFCs had limited oversight and were not required to register with the RBI. Langer.
in. began implementing a for-profit MFI model in order to secure overseas investments52. In 2005 SKS Founder. C. Akula changed “SKS Societies” to “SKS Microfinance” and took it from operating as an NGO to a non-deposit taking NBFC. at 2. The Indian Microfinance Lending Machine.
Shloka Nath. 28.
SKS IPO. SKS IPO.
. at 3. available at http://business. micro-insurance policies. 2010). supra note 32. Forbes India (Oct.com/article/boardroom/the-indian-microfinance-lending-machine/18502/1
SKS followed in the footsteps of Banco Compartamos which went public in 2007. Vikram Akula. At this time SKS’s portfolio consisted of standard group based loans (85%). supra note 32. Commercialization of MFIs – The Case of SKS Microfinance
SKS Microfinance was originally founded as a non-profit in 1998 and was praised as a model MFI until its IPO in July of 201051.inability of MFIs to gain equity through deposits has inspired several MFIs to transfer from an NGO into a non-deposit taking NBFC in order to gain foreign investment50. and small supplemental loans53.
SKS Microfinance went public with a 10. The switch from non-profit to a for-profit model required the creation of Mutual Benefit Trusts (MBTs). these fears were allayed because SKS was relatively less leveraged compared to other MFI-NBFCs in India59. at 1. Id.
. at 6. prior to the IPO. The IPO was hugely successful with new capital of USD $155 million being raised and a valuation 40 times greater than its fiscal year 2010 earnings. Id. SKS was able to draw commercial venture capital from outside India to fuel growth with matching profitability. at 9. at 5. SKS IPO. SKS IPO. SKS has moved from being a 90% locally owned enterprise to having a 72% commercial ownership prior to the 2010 IPO56. In July of 2010. which acquired SKS assets prior to the shift to a NBFC. SKS was able to raise over USD$125 million in private equity55. SKS had a net worth of over Rs. Nath. These MBTs named SKS clients as the After four rounds of
beneficiaries and were able to inject additional equity into SKS54.By changing into a NBFC. at 7. By the end of 2009.3 million women57. supra note 32. supra note 42.
54 55 56 57 58 59
Id. This influx of capital allowed SKS to aggressively expand to the rest of India reaching more than 7. Since the initial investments. This high valuation exceeds the valuation of India’s best performing banks and quickly raised concerns that the company was being overvalued.3% interest being issued on the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). 1.
equity financing spanning 2006-2009. supra note 32. However.016 crore (need to find dollar conversion)58.
. This aggressive competition led to irresponsible lending practices with loans being disbursed without checking the ability of or other financial responsibilities of clients. However. the change created a stark change in culture resulting in the 2. supra note 32. supra note 42. Nath. shortly after reports of dozens of suicides resulting from harassment for non-payment. Allegations of physical threats and verbal abuse to villagers were very prominent during this time.
Implementation of Andhra Pradesh Ordinance and the Collapse of the Microfinance Bubble
D. at 2. at 3. On October 15. and is deemed to be the cause of the rash of suicides experienced prior to the introduction of the ordinance61.Akula claimed that the switch from non-profit to profit-making would be beneficial to the poor as it allowed for greater penetration of services to the impoverished 60 . 2010.200 branches throughout India competing for loans. the southern state of Andhra Pradesh (AP) issued an
SKS IPO. These predatory lending practices were followed by default of many borrowers and the subsequent harassment by SKS employees to villagers.
Washington Post. Loan defaults that were below 2% quickly acted as a contagion among borrowers with default rates sharply rising and an estimated default rate of 58% in February 201165. Although regulation and consumer protection was necessary. and access to new loans upon repayment of existing loans64. more disclosures. India Takes Aim at Abuse of Innovative Microcredit Model. The ordinance called for: the immediate cessation of disbursing and collecting of loans until MFI firms register with local officials. supra note 25.ordinance directed at curbing the abuses against clients62.
Roodman. Repayment Slump Hits Indian Lender. at 1. Wall Street Journal Online (Feb. 26. at 1.
Roodman. available at http://online. 3.
.wsj. These factors include: habitual weekly payments. As this ordinance required the cessation of payments and disbursement of new loans. peer pressure from jointly liable borrowers. a ban on coercive loan recovery methods.com/article/SB10001424052748703652104576121741923730956. the AP ordinance had a disastrous impact on the microcredit industry for all of India. 2010. the first and third incentives for repayment became derailed.
Rama Lakshmi. and better controls on the issuance of multiple loans to one individual63. supra note 25. The result that
followed was massive default on existing loans as confidence in the microcredit system faltered among borrowers. The collapse of the microcredit system occurred despite the Microfinance Institutions Network (MFIN) obtainment of a temporary stay on the AP ordinance66.
Nupur Acharya & John Satish Kumar. The microcredit model is only successful with several key factors that encourage steady repayment from borrowers. supra note 25. Nov.
http://www.php?bid=178 Throughout this time period. The self-regulatory
approach has been backed by MFIs across India as the national government has been slow to pass a proposed Microfinance Development Bill that was introduced in 2007.
See generally. 10. 2010). India created opportunities for new MFIs to emerge69 however did little to create prudential measures because most MFIs operated as non-deposit taking financial institutions. as neither were deposit-taking operations. The most agreed upon factor of India’s microfinance collapse was the lack of regulatory framework that would have encouraged the growth of MFIs while ensuring protection of customers.
III. analysts agree that SKS was not the underlying cause.
India’s Proposed Micro Financing Development Bill As easy as it is to cite the greed and aggressive growth of SKS for the collapse of
the microfinance bubble.org/mfin-glance
Sonali Mehta-Rao. available at http://www. Both had lower entry requirements and few prudential regulations.microfinanceinsights.
. Microfinance Insights (Aug.mfinindia. South Asia Perspective: Fast-tracking Microfinance Regulation. Critics of the self-regulatory approach argue that this agency will lack enforcement power if MFIs do not abide by responsible lending guidelines68. MFIs were allowed to operate as Section 25 companies and NBFCs. As the popularity of MFI’s increased in the 1990s and 2000s.com/blogdetails.MFIN is an organization that was created in 2009 with the intention of creating a selfregulatory organization (SRO) aimed at developing guidelines for responsible lending and increasing financial lending to more low-income households 67 .
trusts. and cooperative banks” which can be interpreted as excluding Section 25 companies and NBFCs73.bd/conference/images/speakers/bb%20mohanthy-nabard. available at http://www. The purpose of this bill was to foster growth and increased outreach of MFIs to the poor while protecting small depositors and vulnerable clientele from exploitation70. However the Lok Sabha71 never passed the proposed bill due to several serious shortcomings.
Mukul Asher & Savita Shankar.A.
Deficiencies of the Proposed 2007 Bill
India attempted to rectify the gap between MFI growth and the lack of regulatory restrictions with the introduction of a 2007 Micro Financial Sector (Development and Regulation) Bill (“MFI Bill”). These shortcomings. Microfinance Bill: Need for Major Re-Think. and Environment – Positions and Perspectives.pdf
Lok Sabha is the lower house of the Indian Parliament.
Id. which will be examined in greater depth below.000 microfinance-
Biswa Bandhu Mohanty. School of Public Policy – National University of Singapore. Regulatory Framework. The 2007 Draft MFI Bill defined applicability as. In numbers this may make sense as these institutions make up a very small percentage of the 30. 1.karmayog. included a lack of defined scope that excluded Section 25 companies and NBFCs from the purview of the bill. “including societies. and a lack of prudential norms in allowing MFIs to accept deposits72. not expanding the bill to include micro insurance and other financial instruments. India’s microfinance sector allows organizations to operate in many forms and is subject to varying levels of regulation. Microfinance Sector in India – Developing a Supportive Policy.mra. Scope should include all operating MFIs
As mentioned above.org/billsinparliament/upload/8457/CFO_Article-final. overstretching the NABARD as both a service provider. available at http://www.
requires high entry barriers and thus is difficult to achieve. Deutsche Gesellschaft für. supra note 36. These special MFIs are able to operate more actively and on a larger scale than traditional trusts because they are permitted to secure traditional bank loans for lending purposes and have done so through the help of ICICI BANK’s MFI partnership program80. at 59. Langer. NGOs. at 58-9. supra note 36.org/system/files/Microfinance_Regulation_in_India_2006.dedicated institutions74.Financial Systems Development. and cooperative banks while the RBI would regulate NBFCs and Section 25 organizations76. Id. Id. Division 41 . available at http://india. at 57. Id. Emerging Scenarios for Microfinance Regulation in India. are responsible for 80% of India’s microcredit outreach75. Through Section 25 of the Companies Act trusts were could transform78 into formal ownership as a limited liability company but were exempted from many of the regulations applicable to for-profit companies79.pdf This transformation. as regulated by RBI. this is a serious error as the top 20 firms. so the proposed Bill would have been beneficial in bridging this regulatory gap.
74 75 76 77
Langer. supra note 36.
79 80 78
.microsave. at 56-7. The proposed MFI Bill would therefore regulate only charitable trusts.
B R Bhattacharjee & Stefan Staschen. The majority of India’s MFIs are set up as non-profits that are minimally regulated. at 56. they have not been very effective at reaching India’s needy population because in order to stay un-regulated these institutions could not take deposits or receive external private funding77. However. However. all of whom fall into one of these two institution types.
000).com/legal-documentations-litigations/laws-of-bangladesh/19131929/the-usurious-loans-act-1918/ The World Bank estimates that over 25% of the population lives below the poverty line. This would mean that MFIs would be at the whim of the courts at determining interest rates and would ultimately hurt the MFI sustainability and growth to reach India’s poor population83. courts consider any amount charged (money or in kind) for expenses. 22. supra note 8. which in India is an extremely high barrier. CGAP Key Principles of Microfinance. The Usurious Loans Act of 1918. To operate as an NBFC an organization must be licensed by the RBI and have minimum capital of Rs. and factors in compound interest. UN Report on Microcredit. The Usurious Loans Act was passed in 1918 and allows the courts to provide relief from exorbitant interest rates. The proposed MFI Bill does not create an exemption for MFIs in complying with India’s Usurious Loans Act82.lawyersnjurists.NBFC’s have been even more successful than Section 25 organizations because of their ability to attract and use foreign investment with limited prudential oversight so long as they do not accept deposits. Available at http://resources. X. 2. 20 million ($450. The reason why MFIs have to charge a higher interest rate compared to conventional loans is because the administrative costs remain constant regardless of the
The UN Report on microcredit expressed this assessment in addition to the Consultative Group to Assist the Poor (CGAP). NBFCs are the most rare form of MFI in India although they are the most successful. Act No. approximately 87% do not have access to formal sources of credit or traditional financial services. In taking account of whether interest is excessive.
. MFIs should be exempt from interest rate caps in order to operate effectively The international community is in agreement that interest rate caps are detrimental to the microfinance industry and works to hurt the poor81. bonuses. inquiries. 1918. supra note 13. Mar. fines. Of the 290 million poor.
development. at 19. Bill No.
85 86 87 88
.org/introduction. 5 lakh (about USD $10. Therefore the costs of are inevitably much higher for MFIs. 2007 (with commentary from Cooperative Development Foundation). supra note 36. CGAP / THE WORLD BANK GROUP. Langer.loan amount84. Critics of the combined service provider and regulator argue that this approach is poor governance87. This new arm requires that all MFIs submit annual financial statements and if MFIs want to engage in deposit taking they must register with NABARD in addition to securing capital of Rs. 41 of 2007 as introduced in Lok Sabha on Mar.
See generally.nabard.000).cdf-sahavikasa. http://www. it would be a better solution for India to require full interest rate disclosure to customers rather than an outright limitation.. Micro Financial Sector Development and Regulation Bill 2007. In addition to thrift activities. Microfinance Consensus Guidelines: Guiding Principles on Regulation and Supervision of Microfinance. requiring a higher interest rate.net/MF%20Bill%202007%20%20Clause-by-clause%20comments. Available at. 20. and supervisory functions86. NABARD would face conflicting interests as both a service provider and industry regulator NABARD has been tasked by the Reserve Bank of India to provide credit. http://www. at 5. It is often hard for the general public to understand why MFIs must charge a higher rate and often blame inefficiency or excessive profits to be the reason85. 3. Although these functions have been critical to the growth of India’s microfinance sector the multiple roles already pose somewhat of a conflict of interest. supra note 69. and has been in existence for at least 3 years89.asp. See generally. The proposed MFI Bill creates a new arm of NABARD called the Micro Finance Development Council (MFDC)88. July 2003. at 60.
Robert Peck Christen et al. Although this is a legitimate concern. Asher.
supra note 67. are regulated by the RBI by requiring them to register and maintain capital adequacy requirements. at 6. Id. Id. supra note 81. 4.
93 94 92
Peck. at 11. A more holistic approach would be beneficial to the microfinance industry because by nature it is sensitive to systemic and default risks92. Bhattacharjee.
The majority of India’s microfinance clients are reached through Section 25 and NBFC organizations. government oversight.
. and difficulties with enforcement94. at § 10.NABARD will be responsible for overseeing the proposed Microfinance Development and Equity Fund. at 23. Uniform prudential requirements should be applied across all microfinance organizations The proposed MFI Bill does little to bring uniform regulation to India’s microfinance industry. (Explaining why a special microfinance regulation would be beneficial to India because existing regulation is very piece-meal). Mohanty. at § 23. Regulation is prudential in nature when it is aimed specifically at protecting the financial system as a whole as well as protecting safety of small deposits of customers and individual institutions93. which among other things will provide loans and grants to MFIs or may be applied to the discharge of any of its other responsibilities90. Prudential regulations are important in ensuring the confidence of clients who are only likely to re-pay outstanding loans if they believe that future loans are at risk. which are outside of the scope of the proposed MFI Bill.
89 90 91
Id. About 80% of current industry is regulated by minimal prudential requirements set forth by the RBI while the new bill seeks to create prudential requirements for the remaining 20%91. This important kind of regulation needs to be balanced with considerations of expenses. supra note 73.
Often non-prudential regulations can be accomplished through Commercial Laws or other administrative agencies. Id. supra note 85. “Any monies which are collected (other than in the form of current account or demand deposit) by a micro finance organization” Development and Regulation Bill. at 20. it would be more prudent to instill higher lending limitations once loans are delinquent.
Thrift activities are deposit taking activities. these important requirements should be addressed to avoid another crisis. tracking. the CGAP consensus has advocated for non-prudential regulation 95 to be balanced with prudential regulation whenever possible96. The CGAP consensus recommends rather than setting lending limitations to be a fixed percentage of an MFI’s equity base98.” Peck. at 11. at 15. Such a rule should not be applied to microcredit because it would make it impossible for an MFI to leverage its equity with deposits or borrowed money. and providing borrowers with truth in lending information about the cost of loans. It is recommended that rather than automatically provisioning percentages of microcredit loans at the time loans are made. and collection procedures99. supra note 81. The most powerful source of security is derived from the soundness of an MFI’s practices and the confidence that it would instill in its customers.
Id. Both of these consumer protection issues were not discussed in the 2007 Draft Bill. lending limitations are a crucial missing component. rather lending limitations should be set based on the soundness of an MFI’s lending.Therefore. “In order to minimize risk.of the bank’s equity base. The bill does requires capital adequacy requirements of 5 Lakh rupees and a minimum operation period of 3 years for MFIs that choose to operate in thrift97 activities. As the recent Andhra crisis occurred in large part due to the lack of enabling regulatory framework. Two particularly relevant non-prudential issues relate to protecting borrowers against abusive lending and collection practices. at 12. Id. The MFI Draft Bill does little to address either prudential or non-prudential regulations for MFIs in India. at 29. However. as demonstrated by the Andhra crisis and in conjunction with the CGAP consensus recommendations. regulations often limit unsecured lending to some percentage – often 100% . at §2(l). Id.
Balance between sustainability and helping those in need. The 2010 crisis illuminated the obvious fact that the microfinance industry is by its nature an unstable industry that must rely on prudent practice and regulations in order to future success and protect the vulnerable customers it services. The targeted clients of microfinance are often the poorest and most uneducated people in the world.
Looking forward to the 2010 Revision of the MFI Bill
In light of the crisis.
requirements. access to financial services is a human right that should be enabled. increase prudential requirements for MFIs. India is once again attempting to pass a more comprehensive microfinance statute in order to create an enabling regulatory environment. Among these factors are more robust prudential regulations. As Yonus stated. consumer protections against predatory lending. and enlarge the scope of the Bill to uniformly govern all MFIs. the key concept of balance must be Balance between prudential and non-prudential
considered at every juncture.
CONCLUSION The crisis in Andhra Pradesh highlights the potential for disaster in this financial
sector. As part of the enabling regulatory environment. India should remove interest rate caps on MFIs. As evidenced from the discussion in the previous section there is much to be desired from the last proposed bill. In order for this to occur. Given a proper and
. With the introduction of the last bill to India’s parliament.B. India has a huge untapped microfinance potential with 70% of poor still without financial services.
IV. key factors were neglected which are essential to a successful microfinance industry. and ensure growth by not limiting interest rates. address consumer protection concerns. an education program that empowers consumers to do more than just borrow money.
26. CGAP further defines the limited role to extend to: 1) creating a supportive enabling environment with macroeconomic stability. The Basal Committee.1312/
. CGAP is arguably the most well recognized guidance with eleven outlined key-principles that have been endorsed by the G8-Summit. http://www. client confidence in MFIs will rebound and future crises can be averted. various international organizations have expressed support and guidance to encourage responsible lending. CGAP FAQ.comprehensive regulatory framework. and develop innovative advisory services to governments.cgap. A. CGAP published the key principles of microfinance with the goal of expanding access to microfinancing opportunities to the poor. IV.. Most notably are the U. It is housed at the World Bank although it remains an independent entity whose purpose is to provide market intelligence. MFIs. CGAP takes the position that governments should create a healthy environment for a microfinance sector to develop but maintain a limited role.org/p/site/c/aboutus/ see generally. http://www. In 2004. donors. and 2) creating a strong regulatory framework for microfinance and boosting supervisory capacity101. CGAP About Us.org/p/site/c/template. and The World Bank through CGAP.cgap. and investors. The aim of the eleven
see generally. CGAP Key Principles of Microfinance The Consultative Group to Assist the Poor (CGAP) was created in 1995 as a consortium of over 30 development agencies100.rc/1. promote standards.N. International Microfinance Regulatory Guidance (not sure where/if to include this) With the success and popularity of the microcredit approach at combating poverty.
7) Interest rate ceilings can damage poor people’s access to financial services. 4) Financial sustainability is necessary to reach significant numbers of poor people.
CGAP Key Principles of Microfinance. In brief. 6) Microcredit is not always the answer. 10) The lack of institutional and human capacity is the key constraint. supra note 8. 11) The importance of financial and outreach transparency. not just loans. 5) Microfinance is about building permanent local financial institutions. 9) Donor subsidies should complement. not compete with private sector capital. 6.principles is to allow MFIs to strive for sustainability while balancing the needs of their vulnerable clients. the eleven principles are as follows102: 1) The poor need a variety of financial services. 2) Microfinance is a powerful instrument against poverty.
. 3) Microfinance means building financial systems that serve the poor. 7 and 11 are the most relevant and will be the focus of the rest of this note. In evaluating the Indian microfinance crisis Principles 4. 8) The government’s role is as an enabler. not as a direct provider of financial services.