Are Banks and MFIs Natural Partners in Financial Inclusion A Report by Microsave

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1 30 th May 2012 Volume 2: Issue 17 Fortnightly Microfinance Newsletter by Darashaw & Co. Pvt. Ltd. Are Banks and MFIs Natural Partners in Financial Inclusion A Report by Microsave In this Issue! Microsave, a consulting firm delivering technical assistance to financial institutions recently published a report Are Banks and Microfinance Institutions Natural Partners in Financial Inclusion? The report recognizes MFIs as an important channel that can be utilized by banks in their quest to achieve financial inclusion. Hereunder we present the key points of the report s analysis: What MFIs can offer banks? Ready access to an established client base and trained field staff MFIs have already established a complete setup comprising of a branch network and hence trained and experienced field staff and captive client base that banks can leverage upon Experience in liquidity and cash management, internal audit and due diligence Their experience of delivering credit services has resulted in most MFIs employing robust systems of cash management and highly efficient internal audit and management procedures. These systems could easily be built upon by banks without being required to make huge investments of time and money Client relationships MFIs existing relationships with clients enable them to understand their livelihood activities and lifestyle and hence financial services required by them. Thus MFIs can be an effective tool that banks can utilize either directly as Business Correspondents (BC) or indirectly by providing key inputs to banks. Although as per current RBI Are Banks and MFIs Natural Partners in Financial Inclusion A Report by Microsave...1 Microfinance Bill finally tabled in Lok Sabha....3 Kerala MFIs seek exemption from Money Lenders Act...5 regulations Non-Banking Finance Companies (NBFCs) are not permitted to operate as Business Correspondents, the report specifically underlines the following possible benefits that could accrue to NBFC MFIs should they be permitted to take up this course. How partnering with banks will benefit MFIs Improved efficiency and accountability By utilizing the technology available to BCs, NBFCs could improve their

2 MARKET PULSE Page 2 efficiency since they could electronically record and track field repayment details, automate cash reconciliations at branches, speed up group meetings which would in turn reduce the case load of field staff Reduced vulnerability to political cycles Since business correspondents cater to the entire gamut of financial services, NBFCs (whether directly as BCs or indirectly by supporting banks) could diversify their area of activities and thus mitigate the risks of political cycles (as evidenced in the Andhra crisis) disrupting the mono product model currently followed by them. Negative Fallouts of the MFI- Bank partnership The report also touches upon the possible threats to MFIs the potential disruptions that could impact MFIs current business. Impact on group meetings Utilisation of BC front end technology runs the risk of the disruption of the conduct of group meetings. For example if the Field officer or group leader acts as the Customer Service Point (CSP), savings activities may also be conducted at group meetings. This would make the meetings longer and consequently reduce the loan officer caseload and consequently the turnover and profitability of NBFCs. On the contrary, BC technology if effectively utilised can also make group meetings cashless and thus reduce duration and/or frequency of meetings. This would be very effective for NBFC MFIs but may be seen as challenging the very core of NGOs. Erosion in repayment discipline The report cautions against the possible negative impact that BC technology may have on the repayment culture that is so inherent to the success of any lending model. Thus, while a reduction in meeting frequency may be seen as a positive, it may result in loss of group liability. Also, the availability of individual products could cause people to doubt the utility of group loans. Further, there is always the possibility of technology not functioning effectively and systems being down. Cannibalisation of existing business NBFC MFIs could see banks as potential competitors to their own business and may consider sharing clients with them as a threat to their own business. NGOs on the other hand may look forward to constant funding support from banks while they concentrate on originating

3 Page 3 MARKET PULSE and servicing loans. Burden on institutional capacity MFIs may be required to ensure that the existing management capacity is adequate to effectively meet the requirements of dealing with the various stakeholders involved in BC operations. This would be the case especially with the small sized MFIs that may be required to employ new people to manage the new strategic relationships. Microfinance Bill finally tabled in Lok Sabha The end of the long wait: The Microfinance Bill is finally tabled in the Lok Sabha For a long time now the Indian microfinance sector has been facing uncertainty on account of lack of clarity on the issue of the ultimate regulatory authority. The absence of clear cut guidelines for operations only added to the ambiguity. To address this, the first Microfinance Bill was introduced in However on account of the dissolution of the Lok Sabha, the Bill lapsed. Further, ever since the Andhra crisis erupted in October 2010, the sector nearly came to a standstill. It was widely expected that the subsequent Malegam Committee Report and the RBI s guidelines on Priority Sector Lending were the harbingers of definite regulations. Unfortunately it took over eighteen months since then for the Finance Minister Mr. Pranab Mukherjee to introduce the Micro Finance Institutions (Development and Regulation) Bill, 2012 in the Lok Sabha on 22 nd May, albeit with a few last minute modifications. Following are some of the salient points from the Bill and their possible impact: It empowers Reserve Bank of India (RBI) as the sole regulator of the Microfinance Sector who can fix an interest rate ceiling (maximum interest rate that can be charged) and other necessary regulations on loans provided by MFIs Andhra MFIs that had been objecting to the State Act can now heave a sigh of relief- with the RBI becoming the sole regulator of the sector, they would be free from the restrictive provisions of the State Act. Non Andhra MFIs fearing the possibility of other states taking the AP route would also be glad now that the fear is extinguished The credit ceiling limit has been increased to Rs.5 Lakhs whereas earlier it was proposed Previous issues of Market Pulse: Register at and log in to access the Microfinance Newsletter section

4 MARKET PULSE Page 4 to be Rs.50,000. This can be extended to Rs.10 Lakhs, as per the discretion of RBI. This means that a whole new target segment of micro borrowers will be thrown open to MFIs. Collection of thrift, pension or insurance services are included under the definition of Microfinance Services RBI has earlier objected to this citing safety concerns for Depositors money. How this concern is addressed remains to be seen Councils would be introduced at three levels: Centre, State and District. These Councils would be able to advise the Central Government on formulation of policies and measures to be undertaken for orderly growth and development of MFIs. For this they will review growth and development of micro finance activities, monitor over-indebtedness caused by MFIs in the state; and monitor whether methods of recovery used by MFIs are in accordance with the guidelines made by the RBI or not. The increased monitoring will make MFIs more accountable and consequently ensure that MFIs operate by the book All MFIs need to be registered with RBI. NBFCs which are already registered with RBI and providing microfinance services can continue without registration It is yet not clear if MFIs already registered as NBFCs would have to additionally get registered as NBFC MFIs with the RBI or their existing registration would suffice MFIs shall create a reserve fund as and if specified by the Reserve Bank, of its net profit or surplus realized The appropriation of this fund would be as per the RBI s guidance. The RBI could also direct the MFIs to invest the funds in unencumbered securities unencumbered securities as it may deem fit. Thus the creation of the reserve would create a comfortable cushion that would help safeguard MFIs from any adverse financial exigencies RBI can also develop a Microfinance Development Fund to provide loans, refinance, grant, seed capital or any other micro credit facilities to MFIs or related agencies The cash starved sector would certainly cheer the creation of this fund that would provide the much needed capital Why the ride may not be a smooth one As per reports, the Bill has not gone down well with the AP government that feels that the Bill will help MFIs instead of the poor.

5 Page 5 MARKET PULSE Editorial Board Shadab Rizvi Shweta Phene Nitin Mohapatra Vinay Pokharna Disclaimer This communication is for private circulation only. It is based on the information generally available to public and considered reliable. This report does not constitute an invitation or offer to subscribe for or purchase or sale of any security and neither this document or anything contained therein shall form the basis of any contract or commitment whatsoever with Darashaw & Co. Pvt. Ltd. Darashaw & Co. (P) Ltd. Corporate Office: , Regent Chambers, 208, Nariman Point, Mumbai Tel no: Fax no: /40 Registered Office: 3, Rajesh Mansion, Dinsha Vaccha Road, Mumbai Also, the Minister for Rural Development, Mr. Jairam Ramesh, who is the member of the Standing Committee that has to give its nod before the Bill is passed, has seconded the AP government s concern that the Bill helps MFIs rather than the poor. Further, considering the time that the Bill has taken just to be tabled in the Lok Sabha, it is anybody s guess as to how long it may take before it is actually passed and becomes an Act. Kerala MFIs seek exemption from Money Lenders Act As per recent reports, the President of the Kerala Association of MFIs (Kamfi), Mr. K. Paul Thomas has requested the state minister for rural development, Mr. K. C. Joseph to exempt state MFIs from the Money Lenders Act. Promoted by Pension Fund Regulatory and Development Authority (PFRDA) under the central government, the National pension scheme Swavalamban Yojana was launched for the unorganized sector in Kerala in August As per the scheme that was introduced with the aim to provide old age pension to Source: Microfinance Bill, The Economic Times, Livemint, The Hindu people working in the unorganized sector, individuals joining the scheme are required to contribute a certain fixed amount per year with the Union Government making an equal annual contribution. The funds thus collected are then invested by the Government for paying out old age pension to beneficiaries The exemption was sought on grounds of the Act becoming a deterrent to the fund raising plans of MFIs- Banks are either unwilling to lend or charging excessively high interest rates to MFIs thereby making operations unviable. Source: Hindu Business Line