India’s new Micro Finance Bill

India’s Ministry of Finance has announced that it will be soon submitting the new ‘Microfinance Institution Development and Regulation (MID&R) Bill to the Cabinet of Ministers for approval and thereafter submit it to Parliament during Parliament’s Budget Session beginning in March 2012.

The Indian MID&R Bill brings the microfinance sector directly under the Reserve Bank of India (RBI), India’s equivalent to our Central Bank. A very interesting development in India is that, although the RBI was reluctant to permit the law to allow Microfinance Institutions (MFI) to accept deposits, the bill as it stands allows MFIs to collect ‘thrift or small deposits’.

The RBI had taken the position that it could not agree to any non bank institution, other than Non Banking Finance Companies (NBFC) to accept deposits from the public. But it was overruled.

In terms of the bill, the RBI has the authority to issue directions to MFIs on a number of issues, including amount of micro loan extended, maximum annual percentage rate of interest, levy of processing fees and insurance premium among other things.

The RBI is made the sole regulator for all microfinance institutions, with power to: register, direct, regulate, inspect, fix interest rate caps, margin caps, setting repayment schedules, standards for account keeping, rating norms, capacity building, management information systems, etc. and prudential norms.

The bill also provides for the setting up of an advisory body, the Microfinance Advisory Council, at national level and Advisory Councils at State level. A Microfinance Development Fund with resources for investment in, training and capacity building of MFIs, making donations, receiving grants, granting loans and other financial support to MFIs and other areas as determined by the RBI.

Welcome move

Analysts in India have welcomed the RBI being designated the sole regulator as the MFI sector has been operating in an area of regulatory uncertainty in India, up to this time. Indian policymakers see the MFI sector as playing a crucial role in the strategy for achieving Total Financial Inclusion (TFI) in India.

The strategy is to provide access to financial services to the rural and urban poor and marginalised by promoting the growth and development of MFIs as extended arms of banks and financial institutions. All MFIs other than banks and cooperative societies will be governed by the MID&R Bill when enacted into law.

In an interesting development, the bill accepts that there is a distinct difference to large MFIs and the smaller localised MF operations, especially when the regulator has to deal and interact with the different categories.

The bill creates a specific category of MFI called ‘Systemically Important MFI’. An MFI will fall into this category when it deploys such amount of funds for providing microcredit to a minimum number of clients as may be determined by the RBI.

The fact that more rigid standards of scrutiny, supervision and prudential regulation will be required by the larger state-wide or multi-state MFIs, as compared with small localised operations, is an important one; it is important that the Indian Bill recognises this distinction.

Applying rigid standards to small developing MFIs will stifle and inhibit their development. Alternatively, MFIs handling tens of thousands of depositors’ money cannot be treated, in regulatory terms, in the same way as small village-based MFIs.

The Indian bill also provides for the appointment of a Microfinance Ombudsman for the purpose of redressing grievances between clients of MFI and the MFI with powers to issue directions to MFI.

Sri Lanka

Some time ago, in Sri Lanka too, a bill for the establishment of a Microfinance Regulation and Supervision Authority (MRSA) for the purpose of licensing, regulation and supervision of microfinance business among other things was made public.

The Finance Business Act No. 42 of 2011 prohibits any lending and deposit taking of all kinds, except certain categories already recognised by law, and the MRSA was said to be enabling legislation providing for microfinance institutions to continue in business, notwithstanding the Finance Business Act. But unfortunately, the Sri Lankan draft MRSA legislation has not yet been enacted into law.

Some comparisons of the SL bill with the Indian MID&R Bill are interesting. There are many areas of similarity and some of divergence. In the SL MRSA, Part II Section 10 (2) defines a microfinance business, as the ‘acceptance of deposits and providing financial accommodation in any form and other financial services mainly to low income persons and micro enterprises’. This is a very broad definition, probably the broadest possible, and Section 10(3) empowers the authority to lay down the criteria for determining who is a ‘low income person’ and what is a ‘micro enterprise’ by gazette.

Meanwhile, in the Indian bill, by Section 2 (f) a ‘microfinance institution’ is defined as ‘an entity (irrespective of its organisational form) which provides microfinance services in the form and manner as may be prescribed, but does not include: a bank nor a cooperative society’.

Section 2(g) defines ‘microfinance services’ as ‘ one or more of the following financial services involving small amounts to: individuals or groups: providing micro credit, collection of thrift, remittance of funds, providing of pension or insurance services and any other services which may be specified, in such form or manner as may be prescribed’.

While in India the Bill makes RBI itself is the regulator, the Sri Lanka Bill provides for the creation of the Microfinance Regulatory and Supervisory Authority (MRSA) and a five-member Board of Directors (S.5[3]), consisting of: an officer of the Ministry of Finance, nominated by the Secretary to the Treasury, an officer of the Central Bank nominated by the Monetary Board and three nominees of the minister, one an accountant, and two professionals or academics in finance, banking, economics, law, management or any other related field with relevant experience.

The minister appoints the chairman, from among the board members who has ‘knowledge in the operation of the financial sector’ (S.5 [5]). Members of the authority should not be players in a microfinance business licensed with the authority (3[7]).

In Sri Lanka the Central Bank, the equivalent of the RBI, has one nominee on the authority. In India there are State level Advisory Councils too, while the Sri Lanka bill does not even refer to the Provincial Councils.

In India the Bill creates by Section 3 the MF Development Council to advise the Government on MF. ‘Persons of eminence with experience in MF,’ some officials and ‘not more than six persons appointed by the minister of whom at least two shall be women’.

Since the SL MRDA Board of Directors cannot by legal exclusion have any active practitioners of microfinance serving on it, it would be useful if an advisory mechanism, similar to India’s MF Development Council, can be created, since the SL act does not provide an institutional basis for the bureaucrats and professionals who are on the board of the MRSA to consult and get feedback from MFI and practitioners on the ground situation and on things they propose to do.

The requirement in India that at least two members appointed by the minister shall be women is very important, though arguably inadequate, as it is estimated in South Asia that 70% of MF borrowers are women. But it is an advance on the Sri Lanka situation. So also the provision for an Ombudsman in the Indian bill, Sri Lanka should emulate that.

Objects of the authority

S.3 of the SL MRSA Bill provides that the objects of the authority are, broadly, to license, register, regulate and supervise the microfinance business; to strengthen and develop and qualitatively improve the microfinance business; to ensure its integrity and transparency; to maintain the confidence of stakeholders in the business; and minimise losses by establishing and enforcing standards of accounting, governance and disclosure for the microfinance business. It is commendable that a developmental object has also been included.

The microfinance sector needs some support to expand its human resource capacity and improve monitoring and evaluation. However, the SL MRSA Bill does not have a provision for a MF Development Fund which Section 29 of the Indian MID&R Bill provides.

The Indian Bill provides that ‘the fund shall be applied to provide loans, refinance, grants, seed capital or any other financial assistance to any MFI’. This is an unfortunate omission in the SL MRSA Bill, especially since the MF business in Sri Lanka has for over two decades had access to concessionary funds and grants for development, from the Janasaviya Trust Fund (JTF) and its successor the National Development Trust Fund (NDTF) and its successor the Sri Lanka Savings Bank – micro finance window.

The INGOs also supported SL MFIs, but today with a claimed poverty head count of only 8.9 and a per capita income of $ 2,800, the international donor community have taken Sri Lanka off their radar – even though we provide as much as 40% of our population with an income support safety net!

While the Indian MID&R Bill recognises what is described as ‘systemically important MF institutions’ by Section 15 and requires these large institutions (portfolio: depositors/borrowers) to convert themselves into a company in terms of India’s Companies Act, the SL MRSA only acknowledges a difference in the various types of MFIs by limiting the rights of certain legal establishments, like companies limited by guarantee and NGOs to operate only in restricted geographical areas: three administrative districts.

The SL bill also authorises the board to fix the core capital for companies which will be granted a license to carry on microfinance business at national level. Commentators have queried why companies limited by guarantee and NGOs have had restrictions imposed on them. The Indian approach seems more practical.

Exemptions

The Indian MID&R Bill by defining an MFI as one which provides a list of prescribed services catches up all players in the sector except the banks and the cooperatives. In Sri Lanka, Section 13 of the MRSA Bill exempts certain institutions such as Samurdhi banking societies and farmer organisations, which are in direct competition with MFI supervised by the MRSA. They all indulge in the microfinance businesses.

Today even licensed commercial banks and finance companies proclaim that they are providing MF. Is there a legal basis, in terms of fair and acceptable classification, for exempting banks, finance companies, Samurdhi and farmer organisations from the Indian and Sri Lankan regulators’ supervision and regulation?

In India, at least it is one and the same RBI, which is the regulator. So there cannot be much divergence and discrimination in equal treatment of the category. In Sri Lanka we find two different regulatory institutions for institutions claiming to be providing the same service (microfinance) to clients.

It may be unfair discrimination and placing microfinance businesses subject to the MRSAs seemingly more rigorously empowered supervision under a disadvantage, due to higher costs of compliance, etc., which may be challenged under the Fundamental Rights (equal treatment of same class of persons) jurisdiction of the courts.

Clear demarcation needed

In Sri Lanka today, there are many institutions and persons who are authorised to broadly to ‘accept deposits and provide financial accommodations’ to their clients. Some of these are specifically referred to in the draft SL MRSA Bill.

In practical terms there must be a clear demarcation of how transactions which are currently covered by these existing enactments, currently in force, will be affected when the draft Microfinance Act is enacted and enforced.

The Cheetu Ordinance, the Money Lending Ordinance and the Pawn Brokers Ordinance are some the enactments which create such institutions. There can and will be a definite conflict of laws. The only section of the draft SL MRSA which deals with this issue is S.41, which merely provides that the draft law will prevail, but the situation that will arise is more complex and may need further clarification.

On the other hand, in the Indian MID&R Bill, while by S.42 provides that ‘this act will override other laws,’ goes on by way of ‘explanation’ to state that ‘MF services extended by any MFI registered with the RBI shall not be treated as money lender for the purpose of any enactment relating to money lender’. The Indian MID&R Bill, unlike the SL MR&SA Bill, is very explicit in this regard, which is a positive factor.

Micro insurance, micro leasing, etc. are financial accommodations which are increasingly becoming popular in Sri Lanka. How will the SL Bill deal with those concepts, in the context of a pre-existing legal regime covering insurance and leasing already in operation?

The SL MRSA Bill will have to face up to these issues. India’s MID&R Bill with its wider definition will catch these financial services up in its definition.

Commercialisation of micro credit

Further, the international trend is that microfinance businesses are securitising themselves and listing on stock markets, to raise funds from investors for their activities, as subsidised funds and donor money is drying up.

For example, the Indian social enterprise called SKS Microfinance is raising US$ 350 million in a stock offering in New York. SKS Microfinance is not the first MFI to go public, but it is the biggest-ever stock offering for the sector. SKS Microfinance has its roots in a non profit microfinance organisation called SKS Society that operates in India and has around 6.8 million borrowers, holding US$ 624 million worth of micro loans.

However, traditional promoters of micro credit like Prof. Muhammad Yunus of Grameen Bank, who awarded the Nobel Peace Prize for his work in the sector, have misgivings over this commercialisation of micro credit.

But since Sri Lankan MFIs will not have access to subsidised funds in the future and donor funds are also drying up, it would be good if the draft act deals with these issues in anticipation, so that there will be the space for Sri Lankan MFIs to resort to these innovations if need be, in the future, otherwise the new SL MRSA Bill will redundant at inception.

There are also restrictions on entities carrying out microfinance business from accessing foreign funds, this seems like unequal treatment, and no other type of financing is subjected to this restriction, other than existing rules and regulations. India’s MID&R Bill does not have such provisions.

Benign neglect

The official attitude in Sri Lanka and India, to the micro finance sector over time has been one of ‘benign neglect’. (This phrase was coined by the late Massachusetts US Senator Pat Moynihan, to describe the Reagan administration’s attitude to coloured Americans.)

Rarely was anything positive done, but there was no great damage caused to the sector either, by official acts. Of course the periodical loan waivers for agricultural and housing loans killed a credit culture painstakingly built up over the years by MFIs.

On the positive side, the Janasaviya Trust Fund’s (JTF) micro credit window brought in over 150 new partner organisations into the MF sector. The National Youth Savings and Credit Cooperative (NYSCO), CBSL’s Isuru project, the credit window of the Janasaviya Trust Fund and Janasaviya Program and the Samurdhi Project mainstreamed Self Help Groups (SHG) and savings mobilisation.

In India the work of the National Bank for Agriculture and Rural development (NABARD) established in 1981 did extensive work with SHGs to promote MF. In India cotton farmer suicides last year in Andra Pradesh and neighbouring states due to multiple borrowing from money lenders, commercial banks and MFI caused uproar and MFIs were unfairly blamed. The political drive to regulate MFI in India came about due to this.

The remedy for over-borrowing is the creation of a database of micro business borrowers. Over-borrowing takes place when one micro borrower takes loans from multiple micro lenders, way beyond his capacity to repay. Since MF loans are small, borrowers are tempted to take loans from multiple sources to source a big sum of money.

India through its Unique Identity Authority is preparing a database of fingerprint and eye iris photos, which would be instantly accessible in real time, where every India will have a photo and a unique number on a swipe card. When this is co-related to MF lender’s data, over-borrowers can be instantly identified.

With every Sri Lankan already having a unique National Identity Card number, it should not be too difficult to develop a similar data base. The SL MRSA Bill should provide the legal basis for such a scheme.

Gender empowerment

There is a huge gender empowerment issue with the microfinance sector in Sri Lanka, since over 70% of the loans have been taken by women belonging to the poor and marginalised sectors of society. There is some recognition of this in the Indian MID&R by the provision for compulsory women representation on the National Advisory Council. This should be reflected in the SL draft, may be by providing for gender equality on the board of the SL MRSA?

Both in India and Sri Lanka, the dynamism and creativity of the MF sector in its role of bringing about total financial inclusion will have to be safeguarded while at the same time having the sector complying with a necessary legal straight jacket of a regulated operating environment.

These are but a few comments on a comparison of the Indian and Sri Lanka draft bills on MF. The achievement of total financial inclusion, both in India and Sri Lanka, is a challenging task and the proposed MF regulatory schemes could very well be a game changer in the battle against poverty and marginalisation in these two countries. It will be interesting to see which country is first in enacting the law. It will expose the reality of policy as against the mere empty rhetoric, in which South Asia revels.



(The writer is a lawyer, who has over 30 years experience as a CEO in both government and private sectors. He retired from the office of Secretary, Ministry of Finance and currently is the Managing Director of the Sri Lanka Business Development Centre.)