Looking at microfinance, dispassionately

salaries and commissions inducing unethical business, and leverage.

―Also, if you look at it, the resource is leveraged; it‘s not just money lending business. The moneylender normally lends out his own money, whereas here the MFI is actually borrowing money from depositors and lending the money. So essentially, he is a moneylender, but a leveraged moneylender.‖

These institutions are no more the not-for-profit ones as envisioned by Nobel Laureate Mohammed Yunus, so regulations are essential. Bangladesh-born Yunus had seen micro lending as a vehicle to lift people out of poverty rather than enhance returns of wealthy investors in private equity funds.

―The idea that MFIs should be treated like banks but given soft regulations is dangerous,‖

said former central bank chairman Mr. Venugopal Reddy.

4.4 Looking at microfinance, dispassionately

Recently in late 2010, microfinance has lot of controversy in India. Part of the reason is that its deadly combination of high interest rates, coercive recovery processes and stories of suicides by farmers, extravagant salaries paid to top microfinance brass and promoters making huge sums selling their stake through initial public offerings gives the sector all the makings of a Bollywood potboiler.

The net result is that the Reserve Bank of India (RBI) has finally stepped in (reluctantly, perhaps) to try and do damage control. Never mind that the Bank really doesn‘t have much of a locus standi . As it warns in the press release announcing the setting up of an expert committee to look into the issue, it regulates only those Micro Finance Institutions (MFIs) that are registered with the RBI as non-banking finance companies (NBFCs) and more importantly, have systemic implications for financial sector stability.

And the reality is that for all the noise being made, as of now MFIs do not pose a systemic risk to the financial sector. Nonetheless, given the high-decibel controversy, the central bank‘s expert committee has been given a wide mandate: review the definition of ‗microfinance‘ and

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‗MFIs‘ and make appropriate recommendations; examine the prevalent practices of MFIs in regard to interest rates, lending and recovery practices to identify trends that impinge on borrowers‘ interests; delineate the objectives and scope of regulation of NBFCs undertaking microfinance by the RBI and the regulatory framework needed to achieve those objectives.

In short the RBI has been asked to see what can be done about the gathering storm clouds over the once-widely lauded microfinance sector. The move is well-intentioned. But the bottom-line is can the RBI ensure proper enforcement of whatever regulations it may frame in a sector characterised by a large number of players and scattered, impoverished, often uneducated clientele who are unaware of their rights?

Or should it limit its role to ensuring the misadventures of microfinance sector do not jeopardise the safety of the banking system since the latter rides on the implicit guarantee of taxpayer money. It could do this very simply by taking away the priority sector tag from lending to microfinance.

MFIs are essentially money-lenders, as the former RBI governor YV Reddy, who is known for making the right, if not always politically correct, statements said recently. But if that is the case we also need to keep in mind the limited success we‘ve had with regulating money lenders and design a suitable regulatory structure – one that lays down some broad prudential parameters without killing the sector altogether.

Too tight a regulatory framework will militate against the essence of micro-finance – informality and flexibility. And will be impossible to enforce in letter and spirit. The far better solution would be to ring-fence the banking system by removing the ‗priority sector‘ tag that provides easy access to funds to the microfinance sector and no less important, educate consumers. Remember there is no dearth of laws in this country; but when it comes to implementation and enforcement it is another story altogether.

Think of all the laws on money-lending. Have any of them made an iota of difference? No, they have not for the simple reason that when people are poor and desperate they will go to money lenders, laws be dammed. Poverty, lack of education and social mores that sanction, any mandate, unproductive (wasteful?) expenses on occasions like funerals, marraige etc, make it

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impossible for the formal banking system to step into the shoes of the money-lender. To the extent micro-finance meets the same kind of needs its place can never be taken by the formal banking system either.

However between a situation like we have today with virtually no rules and one where there is a labyrinth of rules of the kind the Andhra Pardesh Ordinance has sought to impose, some kind of middle path that lays down some rules will at least provide a yardstick against which they can be measured might help. If regulations become like what the wag said about second marriages – the triumph of hope over experience – then we‘ll not get very far.

The trick, as in much else in life, is to get the balance right. Dispassionately!

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