MFI Governance and Regulation

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Dr.B. YERRAM RAJU Regional Director, PRMIA & Member, Expert Committee on Coop Banking, Government of Andhra Pradesh At The Alternate Summit on Microfinance and Inclusive Development 21 st June 2011 Microfinance – Governance and Regulation

Raison de etre:

6/21/2011 yerramraju@prmia 2 Raison de etre Financial inclusion demands nurturing and promotion of user-owned organizations – whether mainstream or sub-stream. Haphazard growth is always a concern and needs to be tackled on time. In the life cycle of institutional building, we moved from the preparatory and exposure phases to a ‘reflection phase’ in the SHG movement. For properly setting up conceptualization and monitoring phases, the time is ripe.

Raison de etre:

6/21/2011 yerramraju@prmia 3 The decision between what is possible in the way of self-help and what is necessary in the way of external help does not solely rest with those who are promoting, but forms part of dialogue with the persons or groups who benefit from such promotion. Players and Regulators have to be different to avoid conflict of interest Proper Governance and Supervision is integral to any organization Governance and supervision can be two distinct functions and can be also performed by different entities. Plurality of regulators is not new but proper understanding between them is imperative for orderly behaviour of institutions and individuals and therefore, the need for a mechanism of coordination. Raison de etre

Financial Regulation & Supervision:

6/21/2011 yerramraju@prmia 4 Financial Regulation & Supervision Prescriptive and mandatory: It is a body of principles, rules, standards, and compliance procedures applicable to financial institutions. Financial regulation does not involve repression Its objective is to ensure efficiency and stability Financial Supervision involves the combination of examination and monitoring of organizations for compliance with financial regulation.

MFI Regulation:

6/21/2011 yerramraju@prmia 5 MFI Regulation “When regulation is warranted, it requires coherent prudential guidelines that will further the growth of the microfinance sector while protecting the interest of small savers and supporting the integrity of the financial sector as a whole.” (Barenbach & Chrchill 1997- Regulation and Supervision of Microfinance Institutions: Experience from Latin America, Asia and Africa, Occasional Paper 1. Washington DC: MFI Network)

Regulatory Considerations:

6/21/2011 yerramraju@prmia 6 Regulatory Considerations Capital adequacy Minimum Capital requirements Liquidity requirements Asset Quality Portfolio diversification Sector Risk Profile Prudential norms Protection from fraud Internal Superintendence Structure. Financial Stability Financial Discipline is therefore sin quo non of regulation.

Development Considerations:

6/21/2011 yerramraju@prmia 7 Development Considerations Largest number with largest good to them Alleviation of poverty Promoting self help Promoting alternate livelihoods Promoting new markets where needed Enhanced outreach for inclusive development Equity is the sin quo non of development effort, more particularly in a country like ours.

Equity and Discipline:

6/21/2011 yerramraju@prmia 8 Equity and Discipline In Financial Sector, these are but one side of the coin. Ensuring them demand proper understanding between the multiple regulators governing the sector. This is where the discussion centers round today. Government and the RBI, the financial regulator have certain issues to be sorted out as emerging from the Ordinance of AP on MFIs and the Malegam Committee Report of the RBI.


6/21/2011 yerramraju@prmia 9 EQUITY “By equity we mean that individuals should have equal opportunities to pursue a life of their choosing and be spared from extreme deprivation in outcomes. There are many market failures in developing countries, notably in the markets for credit, insurance, land and human capital. Some form of redistribution can increase economic efficiency. ” (WDR 2006)

Hence the Question of Equity:

6/21/2011 yerramraju@prmia 10 Hence the Question of Equity Search for equity should be at the very heart of any poverty alleviation initiative, particularly one such as SHG linkage, which works through banks which are themselves profit-making institutions Powerful tendency in any endeavor - those on the margins to be further marginalized, and for those who are already better off to gain the lion’s share of the benefits.

SHG In India:

6/21/2011 yerramraju@prmia 11 SHG In India 1.6bn SHGs in India currently linked with over 25000 bank branches covering 12cr people and has cumulatively drawn loans of about Rs 7000 Crore (US $ 1.5 Billion)-Dec 2005 (NABARD). – AN INCREASE FROM HALF-A-MILLION IN 1994 The world’s largest micro-finance program - overcoming India’s shameful position as home to the world’s largest number of poor people A real impact - it must reach every part of the country, and in particular those places with the largest numbers of poor people

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6/21/2011 yerramraju@prmia 12 However, in some quarters state governments feel that they have good participatory models to substitute MFIs. Needs a debate

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6/21/2011 yerramraju@prmia 13 MFIs enlarged but enterprise development yet to pick up Alternate livelihood promotion is goal only for a few MFIs Savings and alp as parallel efforts demand investment in capacity building of the poor

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6/21/2011 yerramraju@prmia 14 Current Indian Microfinance scenario Annual demand for credit by poor households estimated to range between Rs. 150 bn and Rs. 450 bn. Last year, the total supply of credit to this segment did not exceed Rs. 15 bn. which is 3% to 10% share only. Rural penetration of bank accounts is 18% Limited access to insurance services Small deposit mobilisation is picking up in a big way. Hence proper mechanism with safety & guarantee is required by the poor. Some micro credit dispensers using arm-twisting measures alleged to have led to suicides of some users in the State of AP calling for regulatory intervention.

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6/21/2011 yerramraju@prmia 15 Two Main Goals of Microfinance OUTREACH SUSTAINABILITY Both can be achieved if MFIs have following : Large capital base of its own which can be leveraged Favorable legal structure to mobilise low cost money viz. savings from people Cost effective tools/Productive tools Operationally effective mechanisms

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6/21/2011 yerramraju@prmia 16 Why are there gaps in the supply of formal financial services to the poor Institutional supply constrained by Cost of intermediation Price ceilings Inability of the poor to offer physical collateral Apprehensions about ability and willingness to pay for financial services. Bitter experiences of directed credit programmes like IRDP Institutional factors including staff incentives

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6/21/2011 yerramraju@prmia 17 Why donors/Bankers have opened doors for MFIs? Priority sector lending is the target for the Commercial Banks 5% of net lending portfolio is essential to be invested in Women Entrepreneurs by the commercial banks Microfinance seen as an impressive repayment proposition with repayment rates of >95% & <5% default rate. Thus proving that “Poor are Bankable” The Big untapped market with poor is unfolding which may bring in large volumes of business

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6/21/2011 yerramraju@prmia 18 Issues in Access to Financial Markets for MFIs Limited awareness regarding the availability, source and method of approaching. Lack of proper legal structure with majority of MFIs and are caught in web of different schools of thought on legal status for providing mF services Low capital adequacy ratio Low or nil Return on assets for most of the MFIs. Mostly negative return on assets do not bridge to Financial markets Low competency levels of human resources in understanding of financial products available in financial markets

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6/21/2011 yerramraju@prmia 19 On the Business Side: A boom is setting in Microfinance institutions provided they can grab the opportunity Large volumes are expected, if the delivery mechanism is perfect and loan losses are controlled More business products will come in the next decade Big loan size to borrower will lead to large volumes

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6/21/2011 yerramraju@prmia 20 MFIs & anticipated changes Broad client base across the sectors-agricultural, non-farm and service enterprises Look for large volumes of business with fairly high volume products New technology adopted like smart card, palmtops etc. Human development Need to be highly efficient & competitive in running the operations Change in legal structures to take care of growth

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6/21/2011 yerramraju@prmia 21 Other Aspects Pressure on interest rate on lending by MFIs from Govt. & other financial market scenario Service cost could increase due to demand for more skill & competency required to manage growing MFIs Lower margins do not allow to generate more capital to leverage more funds Commercial banks now see as an important business portfolio Want to enter directly or through MFIs. (ICICI’s aggressive approach) Their money power is higher Foreign Equity is welcome but fortunate organizations are few

Main Issues:

6/21/2011 yerramraju@prmia 22 Main Issues unequal access to finance associated with unequal productive opportunities enforcement systems lax structural issues regulatory issues: interest rates; governance; legal; plurality in regulatory mechanism

Main Issues (Contd):

6/21/2011 yerramraju@prmia 23 Main Issues (Contd) creation of appropriate forms of legal status of shgs in their capacity as informal local financial institutions creation of special law for formal or semiformal local financial institutions with special provision for various forms of ownership by shg, community development associations, cooperatives such a law shall also include stipulations like the equity capital requirements far below that of regular banks; a secondary regulatory authority scope for financial innovations

Main Issues (contd):

6/21/2011 yerramraju@prmia 24 Main Issues (contd) Interest rate risk: is state subvention the right way? How are transaction costs transferred to borrowers in one form or other? Professionalism Profitability of lending institutions When do they enter farm sector and how do they enter?

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6/21/2011 yerramraju@prmia 25 Thank you

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