Microfinance: A developmental dilemma

Tuesday, 12 February 2013 00:00 -     - {{hitsCtrl.values.hits}}

Global controversies and Divi Neguma

The Divi Neguma Act is law. There were reported to be a number of amendments made on the floor of the House at the debate. The final product is not yet, at the time of writing, in the public domain.

The Ministry of Economic Development, (wasn’t there to be a Divi Neguma Department?) has advertised for inputs from the ‘venerable clergy, professionals, retired Government officials… young leaders to ‘provide input’ to ‘achieve the goals and objectives of the Divi Neguma Development Campaign’ – one of which is ‘to provide micro financial facilities for the purpose of promoting livelihood development’. It seems that Samurdhi institutions are to be relabelled as Divi Neguma.


Role of microfinance

The role of microfinance as a developmental tool and a resource for poverty alleviation has always had its promoters and detractors. Three recent publications have brought the controversy into sharper focus.

Hugh Sinclair in ‘Confessions of a Microfinance Heretic’ provides a genuine spectrum of analysis of what the purposes of microfinance is, what positive outcomes it leads to, and what can be done to make it work better.

On the other hand Milford Bateman in ‘Why Doesn’t Microfinance Work’ argues that ‘microfinance not only fails to improve people’s lives’ and that it is ‘inherently flawed and its foundations on half truths make it a barrier to development’.

David Roodman in ‘Due Diligence’ argues that ‘microfinance is only now being subjected to genuine vigour in its analysis of outcomes, there is little evidence that microcredit has a poverty alleviation effect, but that there are foundations to be built upon’.

Critics have described Sinclair’s ‘Confessions’ as a part whistleblower, part autobiography, describing the author’s decades of work in the microfinance sector, working with MFIs in Mozambique, Mexico, Nigeria and Mongolia. Sinclair also worked with the Dutch-based microfinance fund manager Triple Jump and several other high profile funding organisations. Sinclair is also thought to be the anonymous source of the New York Times exposé on corruption within the microfinance industry.

‘Confessions’ is written with the evident frustration and disappointment of a man who has seen his faith in the industry and its lofty ideals shattered by the firsthand view point of the disconnect between what microfinance is supposed to be doing, in a sustainable manner, financial services to the poor and marginalised to help alleviate poverty and the incompetence the author claims to have experienced at the front line of the microfinance industry.

‘Confessions’ has as its opening premise the allegation that the microfinance industry has adopted some of the characteristics of a cult, the idolatry, the dogma, the intolerance and resistance to criticism. The opening chapter is entitled ‘Thou shall not Criticise Microfinance’! It speaks of a cabal of theorists and analysts, wedded to the orthodoxy of Microcredit turning destitute women into burgeoning micro entrepreneurs, for whom the questioning of the orthodoxy amounts to heresy.

Bateman in ‘Why Doesn’t Microfinance Work’ argues that microfinance by its very nature supports only the simplest, least productive and lowest growth potential activities. Most loans are in fact simply used for consumption, which he argues, the World Bank’s Consultative Group on Poverty (CGAP) recognises implicitly in its attempts to redefine microfinance in terms of financial inclusion, ignoring the issue of the micro loans sustainability.

This is linked in turn to the danger of over-borrowing and over-indebtedness, which was brought in stark terms in Andhra Pradesh, by the farmer suicides, which resulted in politicians and administrators going overboard in attempting to control microfinance institutions. This resulted in negative consequences for the microfinance industry and the Reserve Bank of India presenting a draft Microfinance Bill to the next session of the Indian Parliament.

Jacques Toureille, General Manager of the Aga Khan Foundation, a broad private network of development agencies founded some 50 years ago in Asia by Prince Aga Khan, says ‘since the 1990s micro-financing of small businesses has started to become big business… these social funding institutions are established as microfinance banks… they’ve been making a lot of money over a short period of time, getting extremely high returns and making a very large margin.’


Sri Lanka

Notwithstanding these debates at the global level on the efficacy of microfinance as an alleviator of poverty, in Sri Lanka today microfinance seems the flavour of choice and a lucrative profit centre among financial service providers in Sri Lanka.

Almost all financial service providers ranging from licensed commercial banks, finance companies, Non Government Organisations, cooperatives, money lenders, pawn brokers, Cheetu schemes (Rotating Savings and Credit Associations – ROSCAs), registered voluntary social service organisations, registered societies, Government programs, etc. are all promoting themselves as providers of microfinance to the poor and the marginalised.

The popularity of microfinance may have been triggered by Prof. Yunus of Bangladesh being awarded the Nobel Peace Prize for his work with the Grameen Bank of Bangladesh. Ironically, since then, the Government of Bangladesh through its Central Bank has ousted Prof. Yunus from the Grameen Bank. The Government is appointing his successor. Another success going down the drain? The politicians in Bangladesh seem unable to forgive Yunus for trying to start a rival political organisation, some time ago!

Sri Lanka has a very long history of microfinance; the first cooperative rural bank took in savings deposits and gave out its first small loan, what is today fashionably referred to as micro credit, in the early 1900s at Menikhinna, in the Kandy District.

The Government has from time to time promoted microfinance, for example through the Central Bank’s Isuru Project, the Janasaviya Trust Fund (JTF) and its successor the National Development Trust Fund (NDTF). The Sri Lanka Savings Bank now has a special window for wholesale lending to microfinance institutions, using the NDTF loan repayment funds, after the latter was wound up. The current incarnation is Divi Neguma.

The Lanka Microfinance Practitioners Association (LMFPA) a network has a membership of 69 members. There are many providers of microfinance who have not joined the LMFPA. The sector is very large, when one factors in the claimed out reach of the cooperative rural banks and the Samurdhi Banku Sangam. One recent estimate put the number of MFIs at 16,400. Microfinance has an important role to play in gender empowerment in Sri Lanka as it is estimated that over 70% of depositors and borrowers are women.


Spectacular lapses in prudential regulation

In Sri Lanka’s recent history of the financial services sector, there have been some spectacular lapses in prudential regulation which has resulted in depositors losing money. Starting from the crash of HPT, UTI, the collapse and takeover of Mercantile Credit, to Pramuka Bank, to Sakvithi (now in jail for bigamy, nothing to do with the Pyramid scheme he ran in the name of microfinance) to Danduwan Mudalali (deceased) and Dadi Danduwan Mudalali, Ceylinco Shriram, the Golden Key episode, the financial regulator has been found wanting.  A recent newspaper headline screamed ‘Central Bank’s failure on Golden Key comes to light’ in block capitals, lead story in multicolour! One witness before the PSC on the CJ’s impeachment is reported to have stated that the ‘Monetary Board discontinued the investigation’.

The recent sale of the Celestial Residences building on Galle Road, which belongs to the creditors of the bankrupt Ponzi scheme Ceylinco Shriram, to Sino Lanka Hotels & Spa Pvt. Ltd., at an alleged price of Rs. 4.2 billion, when there was allegedly an offer for Rs. 7.8 billion, and the building had been valued at Rs. 9.2 billion, according to news reports, before the Golden Key creditors have been settled, highlights the weaknesses in the regulation of the sector.

While the Central Bank of Sri Lanka is the primary regulating authority for banking and financial services, the Commissioner of Cooperative Development at the national level and his Provincial counterparts, the Registrar of Companies, the regulators under the laws governing ROSCAs (Cheetu), money lenders, pawn brokers, insurers and all other legally-recognised providers of financial services have designated regulators, under which the institutions under their purview have been set up. The efficiency and competence level of these regulators vary from nonexistent, to low levels of efficiency.

The 2011 Report of the Central Bank of Sri Lanka states at page 174, under the caption Microfinance Institutions: ‘The CBSL was involved in preparing legislation for the regulation of microfinance institutions. There are several categories of microfinance institutions that are registered under various laws, but are not regulated or supervised according to prudential criteria. Hence, to safeguard the interest of depositors and customers and also to strengthen the governance and service delivery of these entities, it was decided to bring them under a common regulatory umbrella. Accordingly the proposed law will provide for the establishment of a separate regulatory authority for microfinance institutions.’

In the meantime many of the large MFIs such as Sewa Lanka and Sarvodaya SEEDS have converted themselves into finance companies.



Policy position change

Recently however the policy position has changed. Now in terms of a Microfinance Bill, hereinafter referred to as ‘Draft Bill No. 03’ on microfinance, announced recently as having been approved by Cabinet, the Monetary Board of the CBSL is the regulator for MFIs. The quote from the CBSL Annual Report seems to indicate that this Draft Bill No.03 will be enacted soon. This is a welcome step.

In Sri Lanka, although there is no legal definition as to what specifically falls with the definition of ‘microfinance,’ the Draft Bill No. 03 provides a definition. In Part II section 10(2) of the draft law it is stated that ‘microfinance business’ is ‘the acceptance of deposits and providing financial accommodation any form and other financial services mainly to low income persons and micro enterprises’. The Draft Bill No. 03 on regulating micro finance limits its application to certain companies, Non Governmental Organisations and societies. The bill also provides that the bill will not apply to licensed banks and finance companies.

Further in terms of the Finance Business Act no. 42 of 2012, which places restrictions on the freedom to use the word ‘finance’ and all its derivatives in a company name, among other things, the Communications Department of the CBSL has issued a press release from the Department of Supervision of Non Bank Financial Institutions, stating among other things that, over and above the exemptions provided in the Act itself, by Section 10 (6): ‘The Monetary Board has approved that any company/ organisation which has been carrying on microfinance business and registered under the following statutes as at the effective date of the Finance Business Act no. 42 of 2012 may continue to use the word ‘microfinance’ as a part of its name or description until such time the proposed Microfinance Act is enacted.’

The Finance Business Act does not provide for a provision under which such an order can be made by the Monetary Board, virtually negating its provisions. The statutes are (a) a company registered under the Companies Act No.07 of 2007, (b) any NGO registered under the Companies Act no. 7 of 2007 and Voluntary Social Services Organisations (VSSO) (Registration and Supervision) Act No. 31 of 1980, (c) any Society registered under the Societies Ordinance (Chap.123). This amounts to virtually amending the act, and the legal basis for doing so is not explained.

In any event the effect of this decision is to permit certain institutions which do not presently come within an acceptable framework of prudential regulation from an aspect of a provider of financial services to the general public to continue to undertake microfinance business (for want of a better guide ). When Draft Bill No. 03 is enacted, this conundrum will be sorted out.

Given the weak and ineffective history of the regulators (including Ceylinco Shriram Celestial Residences sale) in Sri Lanka, this is a very high risk strategy, putting the public at large in jeopardy of being defrauded by unscrupulous elements. For example the VSSO and Societies Ordinances provide for a regulator but these bodies do not have the capacity to provide a sufficient level of prudential regulation of the financial services provided by these entities. The Draft Bill No. 03 on MFIs categorically places these institutions under the regulatory regime of the Monetary Board of the CBSL.



Indian example

In the Indian draft law, entities operating under specified existing laws have been exempted, by naming the statute, from the application of the new rules applying to microfinance transactions. This avoids any confusion, which will result when in a case where steps are taken under the microfinance prudential regulations, a person or institution charged can take the defence that they are already covered by an existing law, and the new microfinance regulations do not apply to them.

The Draft Bill No. 03 sorts out this problem by specifying that only the entities specified in the bill can apply for a license. But while the Monetary Board directly regulates licensed MFIs, Samurdhi, Cooperatives and Farmers Banks are regulated by their relevant regulators on directions issues by the Monetary Board in terms of the Draft Bill No. 03.

It would be possible to claim that the principle of equal treatment and protection of the law to persons of the same class, would be violated by microfinance institutions operating under the VSSO Act for example, are subjected to a higher level of prudential regulation than that which the Samurdhi Authority imposes on the Samurdhi Banku Sangam or that with the Commissioner of Cooperative Development imposes on the Cooperative Rural Banks, even while operating under the directions of the CBSL.

The Draft Bill No. 03 provides that the Monetary Board has the power to issue directions to the Commissioners of Cooperative Development, the Samurdhi Authority and the Commissioner of Agrarian Services. It is interesting that the recently-enacted Divi Neguma Act – which takes over the Samurdhi Banku Sangams and renames them Divi Neguma Banku Sangam – provides that the Banking Act and Finance Business Act will not apply to the Divi Neguma institutions. So no prudential regulation of Divi Neguma micro finance? Please note that the Divi Neguma Act is not yet in the public domain. In the Divi Neguma bill the definition of micro finance differed from that in Draft Micro Finance Bill No. 3.

Presently most providers of microfinance services such as Sarvodaya SEEDS, Sewa Lanka Finance, the National Youth Services Savings and Credit Cooperative (NYSCO) are already under some sort of prudential regulation – some by registering as Finance Companies, others under the Commissioner of Cooperative Development, etc. – but the standards of prudential regulation vary.

Microfinance providers under other laws such as money lenders, pawn brokers, Cheetu groups (ROSCAs), are exempted from the definition of microfinance in the Draft Bill No. 03. The fact that in the Draft Bill No. 03 this confusion is cleared up is welcome.

The Indian example of specifically exempting certain pre-existing institutions from the new microfinance regulator seems to be the example we have followed in the Draft Bill No. 03. The Indian Microfinance Institution Development and Regulation Bill approved by Cabinet, by Section 42, says clearly that ‘this act will override other laws,’ further goes on ‘by way of explanation’ to state that ‘MF services extended by any MFI registered with the Reserve Bank of India shall not be treated as a money lender for the purpose of any enactment relating to money lenders’.

This explicitly provides that an MFI in India after the law is enacted cannot claim any rights under the laws applying to money lenders. Such clarity is welcome and should be adopted in Sri Lanka too.

There are many good ideas from the India legislation – such as the Reserve Bank itself being the microfinance regulator, instead of setting up a new authority. An observer from another country who studied Sri Lanka’s dysfunctional inefficient Government department and para statal institutional structure, once told me: “Your country needs a new Government authority as badly as a person needs a new cancerous tumour!”

Sri Lanka has adopted this model of the CBSL itself regulating MFIs in the Draft Bill No. 03 on MFIs. The Indian draft act recognises a distinction between large MFIs and smaller localised ones for regulatory purposes.

At the briefing of the press on the meeting of the Cabinet of Ministers which approved the third draft MFI Bill, it was stated that a three tier system was being adopted in Sri Lanka, certain MFIs directly by the Monetary Board, others through officials like the Commissioners of Cooperative Development, and a third category by registered auditors acting on behalf of the CBSL. The Indian draft also sets up a Development Fund and an advisory body. MFIs in Sri Lanka for decades received subsidised funding from the Janasaviya Trust Fund, and its successors, the National Development Trust Fund and the Sri Lanka Savings Bank, but a new source of affordable money is required.



Great improvement

The discussion on the first and second draft bills on MFIs in Sri Lanka has resulted in the Draft Bill No. 03 being a great improvement on its predecessors. Further improvements could be made in consultation with microfinance practitioners and their apex organisation, the Lanka Microfinance Practitioners Association (LMFPA), and positive ideas from the draft Indian law incorporated. But at the end of the day, some law is better than no law!

Leaving the space for under regulated or unregulated financial service providers is a very high risk strategy, jeopardising the rights and financial security of the general public and society at large. In its Annual Report the CBSL itself admits that ‘several categories of microfinance institutions that are registered under various laws, but are not regulated or supervised according to prudential criteria’.

Whatever the controversies at a global intellectual level, the fact remains that microfinance is a financial instrument which almost all financial service providers in Sri Lanka are today utilising. The Central Bank itself has recognised the need for prudential regulation.

Give the rampant scandals in the financial sector of late, leaving the microfinance sector unregulated is a high risk strategy, which, if at all, compounds the dangers, which micro savers and micro borrowers face. As has been pointed out, this sector is not a new development but has a long history, going back to the 1900s, in Sri Lanka’s financial services sector.

The continued lack of prudential regulation is a betrayal of the legal and moral obligation of the regulator of which cognisance must be taken at the highest level, including the Higher Judiciary which has to ensure the rule of law. In this context the early enactment of the Draft Bill No. 03 on micro finance regulation would be welcome. However the conundrum caused by Divi Neguma being exempted from both the Banking and Finance Business Acts raises major new issues regarding the prudential regulation of the sector.

Notwithstanding these issues, Divi Neguma is launching its micro finance window. It will be good if Divi Neguma provides the space for pre existing MFIs, said to be around 16,400, to continue to operate and may be also support these MFIs through the Divi Neguma Development Fund and the Divi Neguma Revolving Fund. Successful previously implemented models are available. As explained there are many potential pitfalls in the microfinance sector and access to previous experience will help to avoid these.

(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.)


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