Can microfinance be self-regulated?

The Reserve Bank’s recent announcement, recognising industry associations as self regulatory organisations (SRO) is being seen as a positive development for the microfinance industry (MFIs).

But have MFI associations acquitted themselves well enough to deserve this regulatory mantle?

The industry has nearly 30 million clients and a loan portfolio of over Rs. 240 billion. The RBI has now sought applications from industry associations, which comply with specific norms to be recognised as SRO.

The associations must have the financial wherewithal (without being overly dependent on subscriptions from its members) and a third of its board members as independent directors. The SRO is expected to induct all MF practitioners irrespective of size.

Thus, RBI expects the SRO to discharge its functions in the interest of all the stakeholders and not be seen as an industry body.There are very few known industry bodies that have a national presence and bring all MFIs under it.

However, one wonders how an industry association could transform itself into a quasi-regulator. This seems like a tall order when the associations’ operations are funded by member institutions.

Levels of regulation Can the issue of conflict of interest be addressed by merely having independent directors and sourcing future operational funds from those other than practitioners?

The issue is compounded by the fact that a complete inventory of the MFI sector in the country is yet to be completed. Though, the RBI has coherently articulated the regulatory norms for NBFCs and particularly for the new segment, NBFC-MFIs, the enforcement of these regulations holds the key.

Currently, industry bodies primarily pursue advocacy roles for the MFI sector. However, the RBI has conceived an inclusive and transparent institutional structure for SROs, capable of surveillance and reporting to RBI. The RBI performs a regulatory and supervisory role for large number of institutions like banks, non-banks and urban cooperatives etc; therefore, oversight in the case of MFIs is a must, in view of the recent happenings.

Hence, the choice of an “an outsourced supervisory model” as a regulatory mechanism. With an SRO in place, RBI is looking at a layered regulatory structure, with self-regulation as the first layer.

But the track record of the MFIs does not inspire confidence in industry associations-turned-SROs. The acts of MFIs leading up to the AP crisis tells a tale.

MFIs indulged in geographically concentrated lending by MFIs, unmindful of associated risks. There was unhealthy competition among members; lack of lender discipline and inadequate oversight. The industry associations did not bring these irregularities to light. They, in fact preferred to remain tight-lipped and point fingers outside rather than rein in its members.

It needed MF Transparency (a US-based organisation) to tell the world that the actual cost of credit to the poor from MFIs was hovering around 25-50 per cent per annum. But, every crisis needs to be seen as an opportunity to improve.

Pre-requisites for the system The debate would rage on whether self regulation itself would work. If it works, which form of SRO is to be entrusted this job?

Many experts maintain that an effective self-regulation needs to encompass two components: 1) a transparent and reliable standard to measure compliance and 2) a credible enforcement machinery. Without the later, it would be near-impossible to rein in institutional misendeavours.

The SRO should desist from collusive behaviour, or a tendency to overlook unhealthy competition and protect erstwhile member institutions. To gain credibility, SROs will have to ensure transparency in the operations of its members, ensure strict enforcement and be open, free and fair.

By doing this, SROs could ensure an orderly growth of micro finance sector, protecting the interest of microfinance clients and furthering their role in financial inclusion.

(The writers are with the Department of Economic Analysis and Research, NABARD, Mumbai. The views are personal)

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