The AP Ordinance on Microfinance – a solution with more problems
- Tuesday, October 19, 2010, 17:48
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By N. Srinivasan,
Microfinance Focus , Oct 19, 2010 : The objectives of the ordinance are laudable. Protection of low income clients from exploitative practices and enhancing levels of transparency are valid public policy objectives of a sovereign government. High debt levels, multiple operators providing loans as also pressure on repayment rates are legitimate cause for concern. The remedy being applied does not seem appropriate to achieve the objectives stated for introduction of the ordinance.
The drafting of the ordinance leaves a lot to be desired. The definition of Microfinance institution as it stands in the ordinance includes banks, and even SERP and its federations as these entities are either ‘providing loans to low income clients or offering financial support to them’. The definition of low income client is not available either in the ordinance or anywhere else. This leaves wide scope for interpretation. The requirement of display of interest rates does not define ‘interest rate’. Whether flat rates, monthly rates and other confusing rates can be displayed?
The stipulation that ‘interest should not exceed principal’ clearly exhibits the disconnect between the law and ground realities. Most MFI loans are of one year tenor and the stipulation in the Ordinance is seen willing to allow up to 100% rate of interest! With practically no loans beyond three years, this stipulation seems redundant for MFIs, but will hurt bank loans of longer duration. In reality, the stipulation will tend to reduce the duration of loans in all institutions in order to escape revenue loss and incursions in to autonomy of pricing.
While the law prohibits a third loan being given regardless of the source of the two existing loans, the verifiability of information on existing loans of borrowers has not been taken in to account. Given the fact that in AP the numbers of microfinance loans are more than nine multiples of poor households, neither banks not MFIs have any scope of future operation in the state. A survey made last year on access to finance in AP[1] brought out that 83% of surveyed families had two or more loans and that the median number of loans per family was four. Informal loans had been taken by 82% of surveyed families and how to verify these when institutions have to reckon ‘loans from all sources’
The requirement that repayments have to be made in panchayat offices only might hurt the banks as they have visit the panchayat office on due dates. MFIs have a regular system of collection of loan dues in weekly, monthly intervals depending on the structure of instalments, whereas Banks which lend to SHGs get the repayments made in their branches.
The stipulation that effective rate of interest should be made known to the borrower is a valid requirement. It should also define the term ‘effective rate of interest’ and how it is to be computed.
The requirements of the law are that a list of borrowers with details of each loan should be provided to the registering authority at the end of each month. With more than 23.5 million microfinance clients in the state, information handling is set to become a nightmare. The capacity of administrative machinery to handle registrations, monthly returns, complaints, no-objection certificates and penal proceedings may need to be increased manifold. At present the named registering authority (DRDA) is finding it difficult to handle its existing work of district rural development. Monitoring the programmes and ensuring achievement of intended plan outcomes has not been easy at the district level. Loading the authorities with a huge volume of work of a very different nature is bound to cause delays, frustration and generally chaotic conditions around these offices.
The stipulation of returning the loans taken from a second SHG within 3 months could be harsh and might cause distress especially where the funds are used to part-finance income generating activity. If the loan was applied for medical treatment or lifecycle needs such as marriage, the return of money within 3 months would be even more difficult. When loans of adequate size are hard to come by from any single source, forcing customers to refund the loans already availed might end up as disservice.
The threat of fines and imprisonment of directors and staff of MFI for coercive action (which includes repeated visits to the customer for recovery of dues – “frequenting the house or other place where such other person resides or works, or carries on business, or happens to be”) is a sweeping one. Some directors onboard of banks including senior civil servants in Ministry of finance or RBI can be jailed, if a branch manager or field officer of their bank visits a borrower, say, four times a month. Professional independent directors may not be willing to take board positions in financial institutions that have operations in AP.
The fast track courts are a good idea. MFIs by and large do not have access to legal remedies against defaulters. The fast track court mechanism, if implemented well, would provide millions of customers and the MFIs with a judicial option for settlement of disputes.
The infirmities in drafting create a void between intent and application of this ordinance. Lack of definitions or precision in definitions, a disconnect from ground realities of business and inadequate appreciation of the volume of work involved in enforcement of the law would tend make the implementation vexatious for all concerned.
A deeper examination of the law suggests that it is intended to keep SHG lending secure from competition of MFIs. The law creates an uneven playing field by making one of the competitors (the State’s Rural Development machinery that drives the IKP) as the controller and arbiter. By loosely defining microfinance, it subjects IKP and its mechanisms (VOs, Mandal Samakhyas and SERP) also to the ordinance. They also need to register, provide monthly information, ask for no-objection and verify whether borrowers already have two loans including from informal sources, etc. The banks should also comply with requirements of the ordinance as long as they provide loans to ‘low income people’.
While the timelines for application for registration, second loan to SHG members, etc., are specified, no time lines have been specified for disposal of applications. A deemed approval at the end of a certain period from the date of application would have been appropriate. The application for no-objection for second loans and monthly lists of borrowers provide information to the competing institutions and could potentiality breach customer confidentiality, especially in the hands of banks. The basis on which no-objection for second loans would be issued is the information provided by MFIs. The district authority is vested with the responsibility of enquiring in to whether SHGs have understood the loan terms and whether the loan is likely to provide additional incomes before providing a no-objection. The likelihood that registering authority will have more information than the financial institution to take a decision on the appropriateness of the loan is remote. But the mischief potential is that the SHGs can be influenced during the process to withdraw the application from the MFI as the registering authority has responsibilities as a department of the government for the SHG linkage programme.
The propensity to borrow is very high in AP. CMFs’ sample survey in AP brought out that 82% of families had loans from informal sources. The median number of loans taken by households was four. The chances are that three out four of these loans are from the informal sector. The ordinance does not have the capacity or mechanisms to deal with loans from informal sources. High rates of interest and coercive processes are issues associated more with informal lending. Restriction of members from joining more than one self help group militates against basic freedoms granted to people. The restrictions on providing loans to willing customers (whether second or third) erode the freedom given citizens to pursue legitimate business or commerce.
During a recent visit to AP, discussions with Banks and MFIs as also customers of microfinance revealed that recovery rates of loan dues had fallen to around 85% on bank loans to SHGs even while MFIs posted high recovery rates of above 98%. SHGs covered under government’s programmes had a comparatively bad repayment record. Without getting in to a debate on veracity of reported information and underlying mechanics of the recovery effort, the State’s programme is seen to have come off second best. With an intensely monitored and controlled regime if a State run programme is unable to match recovery efficiency of private sector institutions, it a natural cause for concern. But the solution to the problem does not lie in the ordinance. It lies elsewhere. A critical look at the programme design, capacity of staff, institutional development measures relating to VOs and federations and the exit strategies would provide better answers to the problems.
On the part of MFIs the current situation is substantially of their making. Some did not heed good advice both from within and without. Multiple lending and associated problems faced in Kolar were not seriously internalised. High interest rates even in the face of declining operating costs and the resultant high return on assets have been criticised over the last two years. The proposition that high growth rates and accelerated expansion of outreach require high profitability has been questioned. The need for patience in recovering investments and the nature of equity (patient capital) that would best fit institutions in the sector have been time and again debated. Regardless of the ability of customers to pay high interest rates, the underlying political economy issues of doing business with vulnerable customers have been consistently ignored by some MFIs. Even with the code of conduct in place from two networks, deviant behaviour was in evidence. While suicides might not be related to loans at all (and not MFI loans either), by the kind of market behaviour exhibited by some MFIs, the sector added grist to the cynics’ mill.
Regulation should have focussed on rates of return, governance reforms, transparency in dealing with customers, grievance redressal, ombudsman mechanisms and framework for restructuring of debts of customers under stress. The state could have brought down the level of debt related stress by making available soft funds to MFIs for on-lending under conditions similar to those under which Banks in the state lend to SHGs. Instead the State has chosen to adopt a combative stance towards MFIs (may be on account of its perception that MFIs are competitors). This impacts more than 6 million existing clients of MFIs and Rs 4000 crores of loans a substantial part of which is provided by banks out of depositors’ savings. The stance against coercive practices, on account of the publicity, is likely to erode the credit culture, placing at risk the already weak portfolio of banks loans to SHGs currently put at Rs 11000 crores given to about 12 lakh SHGs in the state. Where does this leave the government and the sector? Whether the ordinance will make things better or vitiate the operating environment of microfinance and reduce choices available to people? Between the government and the MFIs (both claim being champions of the vulnerable customers) 25 million households have an uneasy time.
[1] Access to Finance in AP, CMF- IFMR for CMR-BIRD funded by NABARD
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6 Comments on “The AP Ordinance on Microfinance – a solution with more problems”
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Good analysis!
I just wish to add, my thoughts, out of my own earlier experience in the mainstream financing.
1) With variable efficiencies of MIS systems available with different organisations, information management for reporting is going to be virtual hell and additional burden of costs for the MFIs only adding up to the rates of
Interest
2) Even when the directors have to be arrested by the authorities, in the initial stages of heat that may happen but eventually like all the laws and ordinances in our country, implementation may not happen. Though this is wishful thinking, my experience, while I was supervising Asset Repossession in my earlier assignments, was that the Police, in most cases, were quite reluctant to be involved in such financial cases as these departments were themselves overburdened with other work and problems.
3) It is possible that the Government had to take quick decisions in the wake of several stories and interviews with half / not baked “experts”, telecast on the Channels of some TV networks in the state. Some of the interviews were downright substanceless and reeking of sensationalisation.
One thing is certain. The so called recovery agents need to be debriefed and rebriefed to handle sensitive clients and I personally always felt that on the flip side, weekly collections would “Breed Contempt due to Familiarity” and constant demands.
Best wishes
Hemantha Kumar Pamarthy
In Individual Capacity
Mr. Srinivasan,
Excellent analysis! Most comprehensive and insightful review on the issue thus far. Sad that no lessons were learned from past experiences and no one has seen this coming. If not remidied soon this could not only spread to other states but wipe out most part of hard work put in by founding fathers of Microfinance in India. Who might have thought ten year ago that Microfinance would be counted as a devil in the room when the intentions were in fact opposite?
Let us hope wisdom will prevail and the poor will not loose this chance too!
I do agree with the analysis done by Mr. Srinivasan on AP Ordinance. AP Govt. should revisit the ordinance and need to make necessary changes where the both parties (poor & MFI) benefits.
Dear Hemnatha
What is galling is that suicides were given as the reason. In 2005, AP had high level of farmer’s suicides (before the explosive growth of microfinance in AP) forcing PMO to design a special package (in AP, Karnataka,and Maharashtra states). The package is still running in the state in select districts. At that time the government was blamed with inaction against money lenders and banks were asked to write off loans, restructure debts and increase lending for agriculture. Now the blame has shifted to MFIs?
srinivasan
While agreeing with some of Srinivasan’s points on the subject I would like to share some of my concerns with a few suggestions towards solution in the midst of problems.
In the first it is ‘lack of definition of Microfinance’ which caused the concern in this sector., The root cause for all the ‘infirmities in drafting’ and ‘vexatious’ implementation of the ordinance is ‘ambiguous definition on Micro finance/MFI’ being followed by all the players in this arena..(The point has been reiterated many times by me in CGAP Blog and other forums as a solitary soldier in the battle against poverty) Without making it clear, no solution what ever suggested, is possible. Thanks to ordinance and Srinivasan’s remark on ‘lack of definition’ .Both the facts have justifiably sensitized the long neglected issue in MF arena. In this context as a close observer of the sector I am provocated to raise a moot question “Who is responsible for this unpalatable situation. ? Further, ignorantly or innocently or intentionally, the term Micro finance is allowed to get overlapped with micro credit. and the latter over a period, has been allowed to overshadow with present kind of eventualities and erode the inherent values of micro finance .Further, adding insult to the injured, every one ( half baked/baked experts as Paramatha referred in his response ) enjoyed the freedom to define as per their own wisdom. This is irony
Second,. some of the definitions ( WB,ADB,NABARD) by and large indicate MF as a package of financial services including micro savings, micro credit, micro insurance, transfer services etc .as needed by the poor. , As per this definition , the institution which provides these service/s are called MFIs, So besides the banks, the post office and Insurance companies also provide micro savings and micro insurance services respectively to the low income people and deserve the status of MFI. by virtue of their micro financial services .NABARD report ( Taskforce on supportive policy and regulatory Framework for micro finance 1999) indicates “on the same analogy NABARD and SIDBI could be considered as APEX level MF service provider institutions, while RMK could be considered as an apex level MFI.” Then, logically a question arises ‘does this ordinance cover these MFI also’.? In this context it is an imperative need to distinguish between Micro financial institution(MFI) and Micro credit institution (MCI) which confines only money lending services.’. Since their (MCI) trajectory is to become LAB ultimately , it could be better baptized local banker confining to money lending activities. Among others, this kind of clarity in the definition of MFI , probably helps implementation of Ordinance towards solution to the poor community
Third, it is argued that as a consequent to the ordinance, the factors, such as ‘willingness of the borrowers for 2 or 3 loans’ and ‘erosion of citizens’ freedom,’ restrict the legitimate business proposition Here the debatable point .” Is the present sordid situation in this sector is because of or in spite of presence of above factors ?
Fourth pertains to the role of regulators of MF in settling the related issues without creating a need for such a Ordinance at least at the concerned state level . What are the roles of played by BLBC/,DCC/SLBC ( represented by APEX bankers-RBI& NABARD ) ? and the specially constituted coordination forum as per RBI ‘s direction(comprising representatives of SLBC convener banks, NABARD, SIDBI, State Government officials, and representatives of MFIs (including NBFCs) and NGOs/SHGs) in 2006 for discussing on the issues affecting the operations in the sector and solution to the local problems. Are they not accountable in this issues? Is the salvation of the local problem beyond their capability ? How to make these forums more vibrant and proactive in improving health of the this sector.
Fifth, as anguished by Srinivasan, consequent to the ‘combative stance against MFI’ there is likely erosion of credit culture and placement of risk in already weak portfolio of banks to SHG . I agree. In the context of presence of ‘ gentlemen’s agreement’ nature of functioning coordination forums at field level referred in point 4 above in the past four decades with inability to effectively solve the local problems in this sector on the one hand , and inevitabilities of ordinance on the other, there is a need for relooking on the implementation of popular SHG- Bank linkage through MFI (MCI) with the kind of mandatory targeting ( treating as priority sector lending for the banks there by keeping them away from the realities at the ultimate borrowers levels in the field and near collapse of ‘service area concept’ ) mostly for fulfilling budgetary requirements. Leave alone drop out and mortality phenomenon in SHG system
Sixth refers to the stake of state in prioritizing physical infrastructure development there by facilitating the productive functioning of the capital for sustainable income generation in the poor dominated rural area. These factors have also a causal relationship with recovery performance in MF sector. . Here it also merits attention of the report of financial inclusion committee (Rengarajan) “There has to adequate access to physical assets in terms of roads, bridges, canals, warehouses and market yards in addition to electric power and telecommunication for financial capital to be useful. In the absence of all this merely insisting on financial inclusion will not work.. This explains why the credit deposit ratio in some of the eastern states , remains low over several decades” In this context, financial institutions be it MFI or the banks remain helpless as their asset portfolio performance largely hinges on this factor. .. Probably the effective utilization of “ Rural Infra structure Development Fund (RIDF) contributed by the banks in tune with the direction of potential Linked credit plan (PLCP)prepared by DDM of NABARD at district level indicating the credit scheme related infrastructural gap, go a long way at least in one way in smoothening the productivity of the micro credit at the field at micro level and reducing the degree of coercion in recovery process being the core factor leading to this Ordinance .’Prevention is better than cure’
In fine, in the context of weak implementation of regulatory and monitoring practices in this sector , in a way the Ordinance appears to be a blessing in disguise. despite problems. till the market behavior in MF sector gets rejuvenated more ethically and holistically . What is needed in priority for the future is the appreciation of clear definition of the Microfinance concept and candid practice .by all the players.
Better late than never.
Rengarajan
It is great to read an interesting analysis from Mr. Srinivasan. The AP ordinance is a welcome sign but the method adopted is a subject of debate. Every one considers MFI sector as predominantly a social sector. But IPOs and increased ROA coupled with the recent incidents in AP has led to this situation. Micro-loan extended should have been complemented with asset creation but that is not the case in most of the MFIs. Why did not these MFIs take up Rural Housing Loans?? I think we can look to take forward MFI through rural housing where asset will be created, interest syndicated, income increased as expenses are reduced.