MALEGAM COMMITTEE REPORT ON MICROFINANCE PDF

By Ramesh S Arunachalam, Rural Finance Practitioner Malegam Committee Microfinance Report The much-awaited Malegam committee report is laudable because it is the 1st committee report of some significance to attempt the creation on of a national regulatory framework for Microfinance in India. The Malegam committee report must be strongly appreciated because it seeks to legitimize microfinance as an integral part of the Indian financial sector. By recommending creation of a new category — called NBFC MFIs with associated conditions which are perhaps open for discussion — the report has clearly positioned and mainstreamed micro-finance within the framework of the larger financial sector in India. This ensures that micro-finance will come under the purview of the RBI and no longer can microfinance be treated as a fringe activity or as an orphaned child in the larger Indian financial sector. A second aspect that deserves appreciation is the fact that while the report has recommended continuation of priority sector funds for MFIs, it was however made it conditional — especially after recognizing some of the key problems like ghost lending, multiple lending, over lending and attempting to outline some measure to tackle them as well.

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This cap will be calculated on the average outstanding loan portfolio. While this margin cap may be considered slightly low in the context of the present cost structure, it can be justified on the following grounds:- There is no reason why the cost of development and expansion included in the present costs should be borne by current borrowers. As the size of the operations increase, there should be greater economies of scale and consequent reduction in costs in the future. In the last few years, not only has the growth of MFIs been financed out of interest charged to borrowers but they have also made profits which are in excess of what can be considered as reasonable, given the vulnerable nature of the borrowers.

They, therefore, have the capacity to absorb these higher costs till the growth rates stabilize and they achieve the desired scale of operations. The MFIs must be given the freedom to devise individual products and price them differently as also apply different rates in different regions so long as the aggregate margin cap is maintained.

This will also facilitate monitoring by the regulator on the basis of the Annual Financial Statements. Several options are available. For example, The MFI may be allowed to keep the excess income apart and adjust this in determining the interest rate structure in the succeeding year The regulator can create a Borrower Protection Fund and the MFI may be asked to transfer the excess income to the Fund. The Fund can be used for such purposes such as financial literacy, etc. Penalty could be imposed on the MFI.

Access to priority sector loans may be suspended for a period of time during which commercial loans could still be available to the MFI to keep its business going.

In addition, they often recover a variety of other charges in the form of an upfront registration or enrolment fee, loan protection fee, etc. They also recover an insurance premium. It is important in the interest of transparency that all stakeholders in the industry including borrowers, lenders, regulators, etc.

This requires the use of a common format. It is also necessary that the effective interest rate charged by the MFI is prominently displayed in its offices and in literature issued by it and on its website. Insurance to serve this purpose may be mandatory but beyond this purpose should be optional. The premium should also be recovered as a part of the loan repayment installment and not upfront and there should be regulations for the proper disposal of the policy proceeds in the event of the death of the borrower or maturity of the policy or for its assignment on the settlement of the loan.

We have also noticed that some MFIs levy an insurance administration charge. We see no reason why such a charge should be levied. MFIs should recover only the actual cost of insurance.

We are informed that no interest is paid on this deposit. As this deposit is recovered up front from the amount of the loan, this amounts to charging interest on the gross value of the loan when only the net amount is disbursed.

The practice of security deposit, therefore, distorts the interest rate structure and should be discontinued. Further, the acceptance of such deposit is not permissible by the RBI Act. The Card should show this information in the local language understood by the borrower. Security deposits already collected should be returned. There is considerable evidence that these practices are widely prevalent and various reasons have been advanced for the same.

It is also claimed that the emergence of ring leaders as key intermediaries between MFIs and potential customers has distorted market discipline and good lending practices. There are reports that ghost loans have become epidemic in some states. Finally, it is believed that in consequence of over-borrowing, default rates have been climbing in some locations but these have not been disclosed because of ever-greening and multiple lending.

However, three major reasons may be noted. The loans are given for income-generation but often there is inadequate time given to the borrower between the grant of the loan and the commencement of the repayment schedule. In the absence of such a period of moratorium, it is likely that the first few installments, particularly when the repayment is weekly, would be paid out of the loan itself, thus reducing the amount available for investment or paid out of additional borrowing.

It is, therefore, suggested that borrowers should be given a reasonable period of moratorium between the disbursement of the loan and the commencement of repayment. This period should not be less than the frequency of repayment. Thus, a loan repayable weekly would have a moratorium period of not less than one week while a loan repayable monthly would have a moratorium period of not less than one month.

This not only increases profit but also reduces their transaction costs. These borrowers are, therefore, tempted to take additional loans beyond their repayment capacity. Such a regulation would have two advantages namely, Multiple lending and over-borrowing can be avoided as the total loans given to an individual can be more easily ascertained and The risk is shared by other members of the JLG who can impose some peer pressure against over-borrowing.

This can be cured only by a better discipline in the system of identification and data base of borrowers and better follow-up by the field worker. These functions should not be entrusted to a single individual but should need the collective action of more than one individual and should be done at a central location.

In addition, there should be closer supervision of the disbursement function. In addition, there should be close supervision of the disbursement function. This is not possible unless a Credit Information Bureau is established expeditiously. Rather, it should provide a data base to capture all the outstanding loans to individual borrowers as also the composition of existing SHGs and JLGs. When more than one bureau discharges the role, adequate co-ordination between the bureaus will need to be established.

Similarly Sa-Dhan is an association of community development finance institutions which also includes MFIs within its membership. Both institutions have a Code of Conduct for their members. Both institutions have represented to us that they are actively working with a Credit Information Bureau to build up a system whereby MFIs can report to the Bureau the status of all loans granted by them.

Once such a Bureau starts functioning there is no reason why multiple lending and over borrowing cannot be controlled. Given the fact that most loans are given to borrowers in a village and the fact that MFIs have field staff who have sources of information, this should not be too onerous a task.

In the meantime, the responsibility to obtain information from potential borrowers regarding existing borrowings should be on the MFI. While we did not seek any specific evidence about the extent of this malpractice, the very fact that such claims are widely made makes it obvious that the matter needs attention. If these issues are adequately addressed, the need for coercive methods of recovery would also get significantly reduced. They have to accept responsibility for the good conduct of their employees and if employees or outsourced workers misbehave or resort to coercive methods of recovery, severe penalties must be levied on the MFIs and their management.

If this is done, the managements of MFIs, in their own interest, will establish a proper Code of Conduct for field staff and make greater investments in the training and supervision of the field staff to prevent such occurrences.

It also surfaces when the systems of control and inspection are inadequate. These are areas which will have to be monitored by the regulator. There are advantages in requiring recovery from the group as a whole at a central location and this may be specified by the MFI.

This will ensure that the privacy of the group is respected and that there is sufficient peer pressure on the borrower to make the repayments. We believe this problem was significantly reduced by the following measures:- The size of their portfolio was reduced to the levels which they could adequately control.

The use of out-sourced recovery agents was reduced and more of their own employees were used for recovery particularly in sensitive areas. The types of products were examined and recovery methods were fine tuned to recognize the variances in these products. Training and supervision were greatly enhanced Compensation methods for staff were reviewed and greater emphasis was given to areas of service and client satisfaction than merely the rate of recovery.

Some of these methods can be profitably used by MFIs. If this default is of a temporary nature or willful, the MFI may enforce recovery from other members of the Group but if there are external factors beyond the control of the borrower, some time for recovery may need to be given.

It is necessary that there should be a grievance redressal system established by each MFI and for this to be made known to the borrower in the literature issued, by display in its offices, by posting on the website and by prominent inclusion in the Loan Card given to the borrower.

In addition, it is necessary that there should be independent authorities established to whom the borrower can make reference. While these initiatives are commendable it is necessary that there should be an institution like the Ombudsman to whom aggrieved borrowers can make reference. These Ombudsmen should be located within easy reach of the borrowers. This is justified since the banking sector has a large exposure to MFIs and also since the lead bank has the responsibility to promote financial inclusion in the district.

Another suggestion is that there should be a system of mobile Ombudsmen who would visit each village by rotation on specified days. Both these suggestions need further examination. The regulator should monitor whether MFIs have a proper Code of Conduct and proper systems for recruitment, training and supervision of field staff to ensure the prevention of coercive methods of recovery.

Field staff should not be allowed to make recovery at the place of residence or work of the borrower and all recoveries should only be made at the Group level at a central place to be designated. MFIs should consider the experience of banks that faced similar problems in relation to retail loans in the past and profit by that experience.

The institution of independent Ombudsmen should be examined and based on such examination, an appropriate mechanism may be recommended by RBI to lead banks. The Small Enterprises Education and Promotion SEEP network has also designed a template for a consumer protection code of practice to increase transparency in microfinance consumer policies and practices.

This code could have the following core principles. Avoidance of over-indebtedness The commitment to take reasonable steps to ensure that credit is extended only if borrowers have demonstrated an adequate ability to repay the loans and the loans will not put borrowers at significant risk of over-indebtedness.

Capacity Building and empowerment The commitment to capacity building and empowerment through skill training and hand holding.

Appropriate marketing The assurance that non- credit financial products marketed are appropriate. Transparent and Competitive Pricing Pricing and terms and conditions of the financial product including interest charges, insurance premia, fees etc.

Appropriate Collection Practices Debt collection practices which are not abusive or coercive. Ethical Staff Behaviour The commitment that staff will comply with high ethical standards in interaction with customers and that there are adequate safeguards to detect and correct corruption or unacceptable behaviour. Accountability A declaration that the MFI will be accountable for strictly complying with prudential regulations and preventing inappropriate staff behavior together with details of a timely and responsive mechanism for grievance redressal.

Privacy of Client Data The assurance that privacy of client data will be respected. Similar provision should also be made applicable to banks and financial institutions which provide credit to the microfinance sector. This will benefit both the MFIs and the borrowers as it will reduce costs and consequently interest charges and also increase the volume of business. While efficiency at the field level will result in better service to borrowers and greater protection from abuse, efficiency in the back office can result in a greater saving in costs as also better control on the field staff.

Information Technology is a powerful tool in building operating systems for identification of borrowers and communication of data and needs to be fully exploited. It will help in the operation of the Credit Information Bureau, reduce overborrowing and control delinquency without resorting to coercive methods. The use of bio-metrics and the Unique Identification Programme hold great prominence in this area. Therefore, there is also the need to re-examine the regulatory and other requirements to simplify documentation and reduce delays.

Given the small amount of individual loans and the consequent spread of exposure, the cost saving will more than compensate for the risk of loss of control and consequent defaults.

More importantly the group is to be seen as the vehicle through which skill development and training are imparted to the members of the group. A SIDBI sponsored study over a seven year period from records that there was a unanimous demand from group members in all villages visited that skill development and training was required for undertaking any income generating activity and that they felt that a loan alone would not help in improving their livelihood.

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Malegam Committee Report – Summary of Key Recommendations

Please refer to www. Ramesh S Arunachalam Rural Finance Practitioner The much-awaited Malegam committee report is laudable because it is the 1st committee report of some significance to attempt the creation on of a national regulatory framework for MF in India. The Malegam committee report must be strongly appreciated because it seeks to legitimize microfinance as an integral part of the Indian financial sector. By recommending creation of a new category - called NBFC MFIs with associated conditions which are perhaps open for discussion - the report has clearly positioned and mainstreamed micro-finance within the framework of the larger financial sector in India. This ensures that micro-finance will come under the purview of the RBI and no longer can microfinance be treated as a fringe activity or as an orphaned child in the larger Indian financial sector. A second aspect that deserves appreciation is the fact that while the report has recommended continuation of priority sector funds for MFIs, it was however made it conditional - especially after recognizing some of the key problems like ghost lending, multiple lending, over lending and attempting to outline some measure to tackle them as well.

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Malegam Committee Report on Microfinance: What’s On The Platter?

This cap will be calculated on the average outstanding loan portfolio. While this margin cap may be considered slightly low in the context of the present cost structure, it can be justified on the following grounds:- There is no reason why the cost of development and expansion included in the present costs should be borne by current borrowers. As the size of the operations increase, there should be greater economies of scale and consequent reduction in costs in the future. In the last few years, not only has the growth of MFIs been financed out of interest charged to borrowers but they have also made profits which are in excess of what can be considered as reasonable, given the vulnerable nature of the borrowers.

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