Sucheta Dalal :Not If But When
Sucheta Dalal

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Not If, But When  

November 3, 2010

The RBI had better not shirk its responsibility and get down to regulating

Even Suresh Gurumani would not have suspected that SKS Microfinance’s arrogance in sacking him within two months of a hugely successful IPO (initial public offering) would rip the halo from the company and the micro-finance institutions (MFIs) and trigger an unstoppable chain of events. In just 20 days of October, the Andhra Pradesh (AP) government issued an ordinance seeking registration and tougher regulation of MFIs, including stringent penalties and imprisonment for using dubious means to recover loans. Its threat to cap interest has also led to a 2% reduction in lending rates.

The Reserve Bank of India (RBI), which had taken the curious stand that states should regulate MFIs, was forced to appoint a board sub-committee under YH Malegam to examine the issue. CRISIL, which has been rating loan pools of MFIs purchased by banks, has said that it is also reviewing the sector.  All these actions will make sense if they lead to a dispassionate assessment of MFIs, without being influenced by the powerful lobbies working for MFIs who like to dismiss criticism as being alarmist. One can only say that it is precisely this attitude that gave us a global financial crisis in 2008.

As for MFIs, the not-for-profit ones started with the most noble intentions and many retain their integrity, but the for-profit models, with their high expenses, fancy salaries and the pressure to deliver quarterly growth numbers, are certainly on their way to creating a rural sub-prime mess.

Worse, they operate in a vacuum, because borrower credit histories are non-existent and difficult to create, since local moneylenders will not cooperate in their creation. Worse, nobody has bothered to verify how much of the furious growth claimed by the MFIs is multiple loans to the same person being rolled over by their borrowers. In fact, bankers and rating agencies officially accepted their absurd claims of 99% recovery while privately admitting that it was only possible because many borrowers were seeking multiple loans and rolling over one against the other. This is clearly a recipe for disaster at interest rates of 30%, especially when rural incomes depend on the vagaries of the weather and local practices.

As in the US, many academics, scholars and the local media have been reporting the dangerous trend, but they were deliberately ignored by institutional lenders and regulators. SKS’s decision to sack its CEO has triggered a frank discussion. By many accounts, micro-lenders chasing India’s poor rural population with unsecured loans (to show high growth numbers to investors) is leading to borrowing for consumption rather than productive use and only creating a moral hazard.

But there is worse. In an article titled, “The So Called Microfinance Crisis in India,” Dr Oliver Schmidt of the Mountains of the Moon University, Uganda argues that the growth of micro-finance is a ‘serious threat’ to the power of government bureaucracies over newly economically empowered households. And that is why they “have hindered, haggled and constrained microfinance every now and then.” Although Dr Schmidt blames India’s ‘monstrous bureaucracy’ for trying to fit MFIs into a formal regulated structure, I believe that our politicians, and sometimes religious leaders with their compulsion to control illiterate and impoverished rural vote banks, will be the bigger threat to the very structure of the micro-finance business in India.

Dr Schmidt says that MFIs, such as SKS and Spandana Spoorthy, succeeded in using capitalistic methods to create wealth. Indeed, it is this that earned them their halo as well as international awards and recognition, and the rush of private-equity funds and venture capitalists. It was a perfect model which promised extraordinary returns with five-star operations, and yet, the nice glow of participating in social change.

Dr Schmidt says that SKS’s leadership had not digested the consequences of going public in terms of increased media scrutiny and public accountability.

But it is unrealistic to believe that the business could continue as furiously with a weak mechanism to assess borrowers’ creditworthiness and yet ensure recoveries by legitimate means. It is hard to believe that a supernormal growth from India’s rural areas can continue braving all the negatives, such as agents promoting indebtedness, offering new loans to cover old ones, the coercive recovery tactics leading to suicides and the fact that politicians can foment trouble and precipitate massive losses in the run-up to elections by telling borrowers not to pay.

The Reserve Bank of India (RBI) sub-committee headed by Yezdi Malegam also needs to get real about the kind of players entering the business.  In the MFI model of high interest and unsecured lending, it is the ability to ensure high recovery rates (without funding) that is crucial. This brought a certain kind of new lending company into the business. A quick look at the websites of rating agencies shows that the lesser-known MFIs are existing companies that have quickly given themselves a new name to get a new avatar. Some have been securities companies, while others were in the collection business and clearly feel confident of exploiting their core competencies. All of these are growing furiously, securitising their loans, getting them rated and passing them on to banks to meet their ‘priority sector’ lending quota.

How is this any different from the toxic sub-prime assets created in the US against shaky home loans that were dumped by young bankers drawing obscene salaries on to financial institutions around the world? Yes, the problem is just too small and insignificant at the moment, but the model is the same. And it is shocking that the RBI, which has been lauded for the prescience of its former governor, waited until there was an uproar in the media about transparency and governance issues at the biggest MFI before it decided to set up a sub-committee.

The RBI is fully cognizant of major problems in the lending and recovery practices in parts of AP, Karnataka (Kolar) and Orissa, areas where MFIs have grown the fastest. Yet, under the present dispensation, it not only failed to act or to check the quality of securitised assets that were being rated and picked up by banks, but also insisted that regulation of MFIs is the domain of state governments. When the MFIs are aspiring to grow rapidly (meaning that more and more of their securitised, unsecured debt would be absorbed by banks) across the nation, RBI should have been demanding the power to regulate them, instead of shirking its responsibility. It remains to be seen whether the sub-committee headed by Mr Malegam takes a hard look at the sector or merely provides findings to justify the RBI’s hands-off approach. —
Sucheta Dalal

-- Sucheta Dalal