Microfinance Regulation in India [email protected] Sa-Dhan vii Acknowledgement D iscussions for the research outline for this report began immediately after the presentation

Microfinance Regulation in India

MicrofinanceRegulation

in India

Sa-Dhan

New Delhi 2001

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© Sa-Dhan 2001

AuthorsKurumi Fukaya

Narayanan ShadagopanSa-Dhan Research Team (Chapter 4)

Published bySa-Dhan

B4/3133 Vasant Kunj, New Delhi [email protected]

Typeset for print and e-book byAstricks

New Delhi 110070www.astricks.com

Jacket design by Neelima Rao

Rs 225 $ 25

Sa-Dhan — The Associationof Community DevelopmentFinance Institutions

The Mission‘To build the field of community development finance, helpingmember and associate institutions in rendering better servicesto low income households, particularly women, in both ruraland urban India, in their quest for establishing stable livelihoodsand improving their quality of life.’

Aims and Objectives I. To provide a forum for organizations and individuals en-

gaged in the field of community development finance toshare and exchange experiences, expertise and resources;

II. To serve as a catalyst for building these institutions;III. To strengthen the capacities of community development

finance institutions (CDFIs) through research, consult-ancy and training in different aspects;

IV. To disseminate and publish sound financial practicesfrom both national and international;

V. To act as a self regulating organization for communitydevelopment finance institution and seek recognitionfrom relevant regulatory;

VI. To establish linkages between numbers and resources in-stitutions such as funding agencies, financial institutions,

rating agencies, training and consultancy and researchinstitutions;

VII. To establish minimum standard of performance, bothdevelopmental and financial aspects which membershave to adhere;

VIII. To work with other networking and coalition of com-munity development finance institutions; and

IX. To represent its members in governmental agencies suchas RBI, and other regulatory and policy making bodiesso as to promote community development finance andhelp create a favourable policy environment at nationaland international level etc.

(Memorandum of Association, Sa-Dhan, 1999)

Members of Sa-DhanSa-Dhan’s members cover the entire spectrum of microfinanceplayers — NGOs, Non-Banking Finance Companies, Profes-sional support organizations and Specialised Networks. As ofJanuary 2001, Sa-Dhan’s primary and associate members are:SEWA Bank, Ahmedabad; BASIX, Hyderabad; Friends ofWomen’s World Banking (FWWB), Ahmedabad; SHARE, Hy-derabad; Indian Grameen Services (IGS), Hyderabad; ADITHI,Patna; DHAN Foundation, Madurai; AWAKE, Bangalore; De-velopment Support Team (DST), Pune; EDA Rural SystemsPrivate Limited, Gurgaon; PRADAN, Ranchi; CHAITANYA,Pune; Association for Social Advancement (ASA), Trichy; SarvaJana Seva Kosh Limited (SJSK), Chennai; Rashtriya GraminVikas Nidhi (RGVN), Guwahati; Watershed OrganisationTrust (WOTR), Ahmednagar; OUTREACH, Bangalore;HDFC, Mumbai; All India Association of Micro EnterpriseDevelopment (AIAMED), New Delhi; Sanghamitra Rural Fi-nancial Services, Mysore; CARE-India, New Delhi; Microfi-nance Consulting Group (MCG), Chennai; ARAVALI, Jaipur;Bharat Sewak Samaj (BSS), Thiruvananthapuram; ShramikBharti, Kanpur; Grameen Development Services (GDS),

vi Microfinance Regulation in India

Lucknow; Amhi Amchya Arogyasathi (AAA), Gadchiroli;SHEPHERD, Trichy; Centre for Youth and Social Develop-ment (CYSD), Bhubaneshwar; and Kalrayan Hills Area Devel-opment Project (KHADP), Salem.

Sa-Dhan B-4/3133 Vasant Kunj, New Delhi 110070 Tel: (91) (11) 26138932 Fax: (91) (11) 26132629 e-mail: [email protected]

Sa-Dhan vii

Acknowledgement

Discussions for the research outline for this report beganimmediately after the presentation of the report of NationalTask Force on Supportive Policy and Regulatory Frameworkfor Microfinance to the Governor of the Reserve Bank of India.The report besides suggesting the need to encourage the devel-opment of a self-regulatory mechanism went on to define someof the broad parameters under which such a regulatory mecha-nism could be given shape. Specific features that required de-tailed examination, of the Indian context, remained an urgentneed.

This study is an exercise in unravelling the features of theself-regulatory regime for India. Fortunately, the study hasreceived the attention and time of a wide variety of supporters:foremost the Policy Sub-Group in Sa-Dhan, well-wishers andsupporters, prominent among them, Bharathi Ramola-Guptaof Price Waterhouse Coopers, Malcolm Harper and ThomasFisher from the New Economics Foundation. In addition, allthe different stakeholders — members and non-members ofSa-Dhan, central bankers and policy makers, retail bankers anddonors — welcomed the study team warmly and with greatgenerosity with their time. We are thankful for all your insightsand suggestions, which we have hopefully summarized honestlyand clearly in the study.

Further, the work of my colleagues in Sa-Dhan, particularlyRaja who has put together one of the most extensive appoint-ments lists, covering a hundred meetings, stretching fromLucknow in the East to Ahmedabad in the West, and fromDelhi in the North to Madurai in the South, was a delicate

balancing exercise. Assisting in these hundred meetings acrossthe country were a dedicated team of practitioners turnedresearch assistants, who undertook, the at times, arduous jour-ney across the country: Srikant, Santosh Sharma and LangsunT. Mate. They together with the researchers explained, lis-tened, debated and informed the respondents the purpose ofthe study. They met with leaders of organizations, key manag-ers, frontline retail staff and technical service providers. Forcapturing the diversity of views and putting them systematicallyinto a report of high order, one must thank Kurumi Fukayaand Narayanan Shadagopan of the London Business School.

Finally, for turning this document into one immensely read-able and well produced book, we need to thank our editor,Dr Janaki Turaga.

We hope this study stimulates and informs each one of you.

Mathew TitusExecutive DirectorSa-DhanJanuary 2001

x Microfinance Regulation in India

Foreword

During the past few years the role of microfinance as acomponent of poverty reduction strategies has come to be wellrecognized. As a result, increasing numbers of NGOs, as wellas government, bilateral and multilateral funded developmentactivities are including microfinance components in their pro-grammes. This has resulted in a substantial expansion in theavailability of micro-loan and savings facilities for the poor.With a more liberal policy environment emerging, microfinanceinstitutions (MFIs) are also starting to consider micro- insuranceservices for their poor clients.

Despite the recent activity in the microfinance sector, how-ever, its outreach is to no more than 2 per cent of the 60 millionpoor families in the country. And yet, on account of theirunfortunate experience with the Integrated Rural DevelopmentProgramme (IRDP) and other government sponsored lendingprogrammes, the banks are very reluctant to lend to the poor.Improving the access of the poor to capital, therefore, repre-sents a challenge for the microfinance sector.

At the same time, there are opportunities for the microfinancesector. First, NABARD has set a target of one million SHGs tobe covered by the bank linkage programme by the year 2008.The government has provided NABARD with a fund of Rs l00crores (US$ 21 million) for this purpose and for strengtheningthe sector. Second, SIDBI’s Foundation for Micro-Credit(SFMC) has raised substantial funds for providing loan capitalto MFIs and for undertaking a capacity building support pro-gramme for them. The Foundation proposes to have an out-standing portfolio of Rs 443 crores and to cover 1.3 million

clients over seven years. Third, HUDCO, HDFC and otherapex funding organizations such as Friends of Women’s WorldBanking, India (FWWB) have also committed significantamounts to the sector. This means that a substantial increase inthe resources available to the sector is currently taking place.

For the microfinance sector, this situation represents athreat as well as an opportunity. While it is apparent that theadditional resources available will foster a significant increasein the growth of the sector, transforming this into qualityoutreach is a challenge that needs to be managed carefully. Theprovision of financial services means not only the handling offunds that belong to public organizations but also the manage-ment of savings that belong to poor people. The availability ofresources combined with a liberal policy environment couldresult in NGOs or others undertaking microfinance withouthaving a full understanding of the complexities and disciplineof financial management.

It is possible that the entry of under prepared or ill-moti-vated organizations has already happened to some extent. If thegrowth of this important sector is to be managed withoutsignificant disaster stories, it is important that not only arestandards introduced in the immediate future but also that someform of regulation be considered — as in the case of banks andnon-banking financial institutions (NBFCs).

As a network of responsible institutions engaged in thesector, Sa-Dhan has already launched an important initiativeto introduce performance and management standards for MFIs.Over the next few months the draft standards will be discussedwith the MFIs themselves and with other stakeholders beforethey are announced as benchmarks.

The study undertaken here is an attempt by Sa-Dhan toinvestigate the feasibility of introducing some form of regu-lation for microfinancial service provision in India. KuramiFukaya and Narayanan Shadagopan, students of the LondonBusiness School undertook the study. Over a period of twomonths, in mid-2000, they carried out an exhaustive studyinteracting with major stakeholders and groups of stakeholders

xii Microfinance Regulation in India

in the microfinance sector to discuss the issues related tothe introduction of regulation — particularly self-regulation— in Indian micro-finance. They also reviewed the literatureon the international experience with microfinance regulation.Their very well focussed report has helped to clarify theseissues including why self-regulation is required at all, whoshould be covered by it, how feasible it is and what Sa-Dhan’srole should be.

I trust this report will serve as a basis for carrying forwardthe discussion on regulation for microfinance in India and thataction emerging from it will help to foster the orderly growthof this very important sector. Readers are encouraged to com-municate their views both formally and informally to theSa-Dhan secretariat and to members of the Board so thatappropriate action can be initiated in the near future. Ela R. BhatChairpersonSa-Dhan— The Association of Community Development Finance Institutions

Foreword xiii

Preface

The National Bank for Agriculture and Rural Development(NABARD) Task Force Report (The Task Force Report) suggeststhat a body comprising practitioners should organize a self-regulatory body that establishes norms and standards for thepractice of microfinance. The Task Force Report gives variousreasons for establishing a self-regulatory body. The study ex-plores whether and how the self-regulatory organization (SRO)will be able to fulfil the objectives as outlined in the Task ForceReport, whether a SRO is necessary to fulfil the objectives, whatform the SRO should take, and related issues.

Microfinance, has traditionally been practised extensively inIndia — first through the agricultural co-operatives establishedat the turn of the last century, and later through commercialbanks and Regional Rural Banks (RRBs). As a result, India hasone of the largest microfinance banking networks in the world.Why then, does a large gap exist between the supply and demandof financial services in rural India? Is it possible that the largenumber of non-government organizations, both voluntary andfor profit, can fill that gap? What kind of policy and regulatoryenvironment will address the bridging of the gap?

The international experience of microfinance regulation isreviewed for possible relevant applicability for India. Countrieslike South Africa and Philippines are beginning to recognizethat microfinance could be central to achieving overall socialobjectives and that a conducive environment needs to be pro-vided for the sector to grow. Their recent interventions haveas yet had little impact, the philosophy and mindset underlyingtheir institutions is reviewed.

Despite the different philosophical orientations, practitio-ners share a major concern regarding voluntary regulatoryarrangements whether the social objectives of microfinance willbe pushed aside in the quest for a more mature market for thefinancial services to the poor. Concerns such as — will it servethe interests of the most powerful? Would the rules be tooonerous to comply with — are shared with organizations un-dertaking voluntary regulation.

Practitioners were unanimous that the Government of India(GoI) should not be excessively involved in the process of altern-ate, self-regulatory framework. Despite differences about therole of the SRO among the practitioners in the microfinancesector, consensus exists for a self-regulatory framework to caterto the Indian microfinance market.

xvi Microfinance Regulation in India

Contents

Front Cover

Half-Title i

Title iii

Copyright information iv

About Sa-Dhan v

Acknowledgement ix

Foreword xi

Preface xv

1. Introduction 11.1 Background 1

1.2 Concept of Microfinance 2

1.3 Methodology 3

1.4 Layout of the Book 4

2. Microfinance and Regulation 52.1 What does regulation accomplish? 5

2.2 Principles of Regulation 5

2.3 Regulation versus Supervision 7

2.4 Costs of Regulation 8

2.5 Constraints to Regulating 8

3. Rural Credit in India: State Interventions 103.1 Government Sponsored Programmes 11

3.1.1 IRDP 113.1.2 Priority Sector Lending 123.1.3 Regional Rural Banks and the

outreach of formal institutions 133.1.4 Causes of poor performance of RRBs

and commercial banks 133.1.5 NABARD and SHG-bank linkage

programmes 15

3.2 Co-operatives 163.2.1 Government control of co-operatives 163.2.2 Mutually Aided Co-operative Societies

(MACS) Act 173.2.3 Is an enlightened Co-operative Act

sufficient for ensuring stability of the financial system? 18

4. Microfinance Services in India 214.1 Introduction 214.2 The Task Force on Microfinance

Regulation 224.3 Emerging Microfinance Institutions

in India 234.3.1 Legal Forms of MFIs 234.3.2 Operating Models of Retail MFIs 24

4.4 State Regulated Microfinance Intermediaries 244.4.1 NBFCs 254.4.2 Co-operative Banks 25

4.5 Unregulated Microfinance Intermediaries 264.5.1 NGO-MFIs 26

4.5.1.1 Retail NGO-MFIs 274.5.1.2 SHG Federations 284.5.1.3 Apex Institutions 31

4.5.2 MACS 324.6 Conclusion 32

xviii Microfinance Regulation in India

5. International Experience in MicrofinanceRegulation 345.1 Different approaches in Microfinance

Regulation 345.1.1 Initial Steps (No Regulation) 345.1.2 Self-Regulation 355.1.3 The hybrid approach 375.1.4 Existing law 375.1.5 Special law 39

5.2 Specific experiences with different approaches 415.2.1 Initial Steps: Philippine Coalition for

Microfinance Standards 425.2.2 Self-Regulation: Credit Unions and

Co-operatives 435.2.3 Hybrid approach: Microfinance

Regulatory Council in South Africa 445.2.4 Existing law: BancoSol in Bolivia 465.2.5 Special law: PFFs in Bolivia 48

6. Self-Regulation in India: Concerns and Prospects 516.1 Why self-regulation in the Indian

microfinance sector? 516.2 Objectives and benefits of self-regulation 526.3 Who should come under self-regulation? 566.4 What should SROs do? 576.5 Who should be SROs? 586.6 Typology of SROs 596.7 How feasible is self-regulation? 626.8 Dissemination Workshop: Issues

and Concerns 65

7. Self-Regulation: Potential and Pre-conditions 687.1 Potential of Microfinance Regulation

in India 687.2 Pre-conditions to self-regulation 71

Contents xix

References 73

Annexures 75

Back Cover

Tables and Figures

Box 4.1 State Profiles: Maharashtra and Orissa 29

Table 4.1 NABARD’s Bank-SHG Linkage Programme 27

Table 5.1 Approaches in Microfinance Regulation 35

Table 5.2 Initiatives in different approaches 41

Table 6.1 Concerns and doubts on self-regulation 65

Table 6.2 Activity/Institution approach based Regulation 66

Figure 6.1 SROs by Region 60

Figure 6.2 SROs by Institution Type 61

Figure 6.3 SROs by Maturity 61

xx Microfinance Regulation in India

1

Introduction

1.1 BackgroundThe NABARD Task Force Report (1999) (The Task ForceReport) suggests that a body comprising of practitioners shouldorganize a self-regulatory body that establishes norms andstandards for the practice of microfinance. The Task ForceReport gives various reasons for establishing a self-regulatorybody. The study explores whether and how the self-regulatoryorganization (SRO) will be able to fulfil the objectives, whethersuch a body is necessary at all to fulfil the objectives, whatform the SRO should be, and related issues.

The term ‘regulation’ means ways in which the govern-ment, motivated by various reasons, makes rules for peopleand institutions in a society by legislation or decree. Histori-cally rules have been established by government functionand voluntary action. Market rules enable efficient and pro-ductive transactions by constraining and governing decision-making powers and actions. In the microfinance sectordifficulties arise regarding the source of the regulatory frame-work — where do the rules come from, who makes them,who decides on the penalties, and who does the policing?The prevailing view in India, as in many other places, bestowson ‘the State’ the task of establishing and enforcing therules. Public and political apprehensions about potential crisesand the assumption that the government has a solution withmore benefits than costs result in state regulations forcingout alternative arrangements. Such a position implies thatother arrangements are inherently less effective and proneto varied conflicts of interests and opportunistic behaviour.

The alternative to state regulation is a continuum of voluntaryregulatory arrangements.

Regulation of financial services to the poor is consideredbecause:

1. The vast majority of moral hazard problems potentiallyoccur in financial services;

2. A systematic erosion of faith in the economy poses longerlasting problems in society; and

3. Non-Government Organizations (NGOs) providingfinancial services is the fastest growing segment of theNGO population.

1.2 Concept of MicrofinanceThe study has adopted The Task Force Report’s definition ofmicrofinance which is ‘the provision of thrift, credit and otherfinancial services and products of very small amounts to the poorin rural, semi-urban or urban areas for enabling them to raisetheir income levels and improve living standards’ (1999: 17).Thrift implies savings created by postponing almost necessaryconsumption while savings implies the existence of surpluswealth.

Much of the existing literature on microfinance focuses onexperiences in Latin America and Africa which is differentfrom the Indian experience. Consensus that the practice ofattending to the financial needs of the poor is nowhere thesame, exists among the international practitioners. The diver-sity of the practitioners and clientele makes defining basicdefinitions difficult.

Credit to the poor by banks and microfinance institut-ions (MFIs) is usually extended without any collateral re-quirements. Some part of the high interest-rates charged tothe poor reflects the riskiness of unsecured loans. The loansare based on subjective assessments of the borrowers’ abilityto repay. The features of micro-credit are — small loansfor working capital or consumption; informal appraisal of

2 Microfinance Regulation in India

borrowers and investments; substitutes for collateral such asjoint-liability groups and compulsory savings; training forboth skills and fiscal discipline; larger repeat loans based onpast loan performance; and low costs loan disbursement andrecovery.

1.3 MethodologyThe research methodology adopted was literature survey andinterviews with key stakeholders in the sector in India. A surveyon literature covering regulation both within and outside mi-crofinance was carried out. The literature on microfinanceregulation is not extensive and largely consists of summaries ofworkshops or discussion papers (see References), as the field ofnon-government sponsored microfinance programmes is stillyoung, MFIs are subject to little regulation and hence there islittle experience in regulating them. However, considerableliterature and experience of other financial institutions withregulation (and self-regulation) exists.

Key stakeholders like the Reserve Bank of India (RBI),NABARD, MFIs, NGOs, multi-lateral agencies, donor agen-cies, institutions and consultancies involved in microfinance inIndia (Annexure 1) responded to the following questions:

• Why did the institutions feel the need for a SRO?• What benefits did they expect to be brought to the

sector by an SRO?• What benefits would accrue to them by belonging to an

SRO?• What form should the SRO take — by region, institu-

tional, size and maturity or all-encompassing?• What were their concerns in belonging to an SRO?

In some instances questions were modified for institutionsfaced with the issue of self-regulation for the first time. A modelof self-regulation was put forth to the institutions to criticize.Approximately 100 meetings were held across the country withdifferent stakeholders.

Introduction 3

1.4 Layout of the BookChapter 1 — The introduction sets the contextual backgroundof the study, the concepts and methodology adopted; Chapter 2— Microfinance and Regulation, addresses the issues in regu-lation; Chapter 3 — Rural Credit in India: State Interventions,examines the state initiatives in the development programmesand co-operative sector; Chapter 4 — Microfinance Services inIndia, delineates the range and issue across the stakeholders;Chapter 5 — International Experience in Microfinance Regu-lation, examines worldwide experience, landmark initiatives, de-velopments and their relevance and applicability to the Indiancontext; Chapter 6 — Self-Regulation in India: Concerns andProspects, addresses the concerns and prospects vis-à-vis self-regulation in India which are discussed by extensively drawingfrom the field data and dissemination workshop and finallyChapter 7 — Self-Regulation: Potential and Pre-conditions,summarizes the current situation and suggests ways of resolvingthem.


2

Microfinance and Regulation

2.1 What does regulation accomplish?The regulation and supervision of MFIs has the larger aim ofdeveloping a niche market based financial system for all prod-ucts — credit, savings, insurance, transfer facilities and otherservices for the clients. A market-based financial system, as-sumes the existence of sufficient competition and incentivesto provide the lowest-cost services possible to clients, wherecost includes all costs — interest rates, transaction, and monit-oring. The ultimate aim of MFIs and NGO facilitators in-volved in financial services for the poor ought to be to‘mainstream’ their client base to avoid the marginalization ofthe clients vis-à-vis financial services. The corollary aim israising the standard of practice, making it sustainable andenabling it to contribute to the development of the financialsystem.

In the Indian context, MFIs are highly dependent on donorfunds to carry out their capacity building activities. Donorfunds will not keep pace with the rapidly expanding microfi-nance sector. Furthermore, the risk of the donor funds dryingup is quite high if the better known MFIs go bust, which willaffect all the players in the microfinance field, irrespective ofthe institutional form.

2.2 Principles of RegulationThe motivation for regulatory intervention is based on theassumption that an asymmetry of information exists betweenthe lender and the borrower. The borrower knows more about

what he is going to do with his funds and his ability to repaythan the lender. In deposit-taking, the financial institutionknows more about how the deposits are going to be used or itsown solvency than the depositor. This asymmetry of informa-tion results in problems of ‘adverse selection’ and ‘moral haz-ard’ in the transaction. (Staschen 1999a)

Regulation to match the actions of the institution (agent)and the client (principal) exists and is accomplished in threeways — control the actions of the agent, restrict the decision-making power of the agent, and set appropriate incentives forthe agent such that the interests of the agent and principal areharmonized. The last option, while least costly in terms ofmonitoring, is the hardest to design. The first two optionsinvolve a supervising agency with statutory authority to controlthe agent and lead to inefficiencies in the market. In economictheory (but not in development finance), the manager’s role isto maximize his information advantage not only over his com-petition but also over the clients which is curbed by regulation.In practice, all three methods are employed to regulate financialinstitutions.

The reasons for regulation are:

1. Since it is difficult and costly for a depositor or aninvestor to monitor closely the performance of an insti-tution, the danger of a run on the institution is present.The definition of ‘run’ is expanded in the study from awithdrawal of all deposits motivated by panic leading tothe bankruptcy of the institution to the withdrawal ofinvestor and donor funds. Runs have knock-on effects— a run or collapse of one institution might precipitateruns on other perfectly viable institutions which is linkedto the drying up of donor funds following failures of‘good’ MFIs.

2. Even if MFIs that do not take deposits (except for ‘earnestmoney’) and refinance themselves through external fi-nance and donor funds, MFIs are liable to behave oppor-tunistically, that is pursue personal gain at the expense of


the creditors. Regulatory measures might curb this kindof opportunistic behaviour. The argument is put forththat funders should exercise the responsibility to do theirdue diligence on the institution to which they are lendingwhile regulation should play only a small part and that thecosts of due diligence should not be incurred by someoneelse (for example, the RBI). Regulation can act as a signalto prospective investors that a particular institution isfinancially sound. Access to certain channels of revenuesmight be contingent on regulation. Some regulatoryframework is necessary if the ultimate aim is to expand,scale and mainstream this segment of the financial system.

Thus regulation attempts to accomplish limiting the danger

of opportunistic behaviour on the part of the institution (con-sumer protection) and preventing unwarranted runs on thesystem thereby ensuring stability. If public deposits are notmobilized, then regulation should be kept at a minimum. Butif deposits are mobilized, the RBI should monitor in the samemanner as it monitors banks. For institutions not mobilizingpublic deposits, the issues of consumer protection and govern-ment regulation are not relevant.

2.3 Regulation versus Supervision Regulation is the provision of rules while supervision is themonitoring and enforcing of the rules. Regulation and supervi-sion can be done by different entities as done in India where theRBI makes the rules and the NABARD enforces them on finan-cial intermediaries in the rural sector. Supervision is the keyelement as regulation without supervision is pointless and willviolate fundamental principles such as providing a level playingfield for the market participants. A serious problem currentlyfacing the RBI is the number of institutions applying for Non-Banking Finance Company (NBFC) status. Since it is almostinconceivable that the RBI can properly monitor them, the endresult will be that other departments in Government of India

Microfínance and Regulation 7

(GoI) will try to reduce the ‘slack’ by imposing constraints thatmay essentially kill the market. For example, in the event of thenon-relaxation by the Home Ministry of the constraints ofForeign Contribution Regulatory Act (FCRA) regulations in anera of globalization will certainly hamper the practice of certainmicrofinance models. Unless explicitly stated otherwise, thestudy uses regulation as inclusive of regulation and supervision.

2.4 Costs of Regulation As government regulation has grown in recent years, seriousconcerns have emerged about the total costs of regulationswhich are difficult to estimate. The government budget costsare only a small part of the overall costs. The ‘compliance’ costsare the costs incurred by the institutions that are regulated, andthese costs are typically estimated to be 50 times the budgetcosts of regulation. The more serious ‘invisible’ costs (Blundell1999) that is, the adverse effects on enterprise development andless efficient markets are not yet known. For the government,the cost of regulation is mostly external that is, the governmentdoes not incur the bulk of those costs and when the bulk of thecosts does not fall on the regulators, regulation is likely toexceed its optimal level. Hence the government, as a monopolyprovider of statutory regulation will bring in levels of regulationwhich exceed the justified levels of all costs and benefits. Giventhat government regulation is difficult to change because of thelength and complex political process, regulation always lagsbehind innovation and change occurring in the system andthereby doe not relate to the present.

2.5 Constraints to RegulatingGovernment departments are compartmentalized into variousfunctions addressing direct different aspects of governance. Atypical NGO provides various services to its clients — educa-tion, training, health-care and financial services are bundled and,in areas where these services are poor or nearly non-existent,


are integrated. Though the government’s role in monitoringand controlling the NGOs is based on its obligation to maximizesocial welfare, it is not clear which government organizationwhether the Ministry of Education, Health Services, the CentralBank, or some other department is vested with the responsibilityfor controlling the NGO. Theoretically, with proper coordina-tion, all the relevant departments could monitor the NGOwhich in practice, is very costly — both to the government andto the NGO, which are prone to various bureaucratic problems.Ideally, government organizations should provide an integratedapproach to monitoring but considering the evolution of gov-ernment institutions, this is hardly a practical suggestion.

One of the unintended consequences of government regu-lation is accumulation of layers of regulation which results inless transparency and democratic accountability. The intellec-tual basis for government intervention as articulated by the‘public interest’ theory of regulation is that the state shouldstep in when ‘public interest’ objectives are not met due to‘market failure’. It is assumed that the government is an altru-istic and omniscient body which can unfailingly detect andcorrect the problems without any self-interest and politicalconsiderations. Consequently, the invisible costs of regulationresult in higher prices and lower standards for consumers asevident in the Indian experience of microfinance (AIAMEDand Opportunity International 1999). Government regulationcan be very oppressive with respect to setting rules as it focuseson a particular process or situation for example the crisis in-volving a large NBFC in India.

The tenuous foundations of principles on which practicalregulation rests leads to many difficulties, and it should not beassumed that ‘on balance’, government regulation will result inmore benefits than costs.

Microfínance and Regulation 9

3

Rural Credit in India: State Interventions

The history of microfinance in India is much longer andmore complex than other developing nations. For many othercountries, the experience of extending credit on a systematicbasis and on a large scale to the rural population is new whichgives them the advantage of a fresh start without resorting toretrofitting new programmes into existing regime. Though thedisadvantage is their lack of experience vis-à-vis the behaviourof rural poor towards microfinance programmes.

Credit demands in the rural sector were largely met byco-operative societies till the mid-1960s. Until then, the com-mercial banks’ presence in rural India largely supported agri-business and marketing. The amount of credit flow to the ruralsector was never sufficient to meet the demands, and one ofthe objectives of bank nationalizations that occurred in 1969and 1980 was to increase the flow of credit to the rural popu-lation. According to the RBI and NABARD the largest micro-credit programme in the world was institutionalized by the GoIthrough its various poverty alleviation schemes, most notablythe Integrated Rural Development Programme (IRDP). Theeconomic crisis in the beginning of the 1990s forced the GoIto re-examine its economic policy, necessitating in a reorien-tation of the economy from centrally planned to market-based.One of the lessons drawn from the gradual demise or transfor-mation of planned economies all over the world is that a mar-ket-oriented approach leads to more efficient resourceallocation than in planned economies. It is our contention that

a market-based approach is not at odds with developmentalgoals. Hence if the aim of the government and microfinancepractitioners is to ‘mainstream’ the rural poor, it necessarilyrequires the introduction of markets, without which the ruralpopulace instead of relying on the invisible hand of the market,will be dependant on the divine hand of the government.

3.1 Government Sponsored Programmes In this section, an overview of the programmes and channels ofdisbursing credit and mobilizing deposits in rural areas in Indiais discussed. The perspective is two-fold — the lack of anymarket-based incentives for performance for the channels (thatis, commercial banks and RRBs) of credit and deposit mobiliza-tion and the continued use of lending technology which hassystematically eroded credit discipline and has made the practiceof microfinance difficult in India than in many other developingcountries.

The GoI added one more channel to reach the poor throughcredit. In the sixth five-year plan, the government launchedseveral anti-poverty programmes like, Integrated Rural De-velopment Programme (IRDP), Training of Rural Youth forSelf-Employment (TRYSEM), Development of Women andChildren in Rural Areas (DWRCA), National Rural Employ-ment Programme (NREP) and Rural Landless EmploymentGuarantee Programme (RLEGP).

3.1.1 IRDPIRDP was launched in 1979 in 2,300 selected communitydevelopment blocks and from 2 October 1980, it was extendedto all the blocks in the country. IRDP was aimed to promoteself-employment with the provision of productive assets topoor households by providing them soft bank loans with acapital subsidy upto 50 per cent. The total number of bor-rowers brought under the scheme till November 1998 were53.8 million involving a credit flow of Rs 19,500 crores. De-spite massive outreach, the impact of the programme in terms

Rural Credit in India: State Interventions 11

of upliftment of households above the poverty line was dismalat 16–18 per cent.

Over nearly two decades of its existence, the IRDP pro-gramme has extended credit to 55 million families (not 55million different families due to many repeat loans). The repay-ment rate in the IRDP programme has been abysmal — in thevicinity of 25–33 per cent with the result that the amount ofloanable funds is not as large as it could be due to poor recyclingof funds thereby possibly reinforcing the Indian banker’s notionthat the poor are not credit-worthy and lastly for the ruralperson, ‘government loans’ and ‘subsidies’ have become synony-mous. The IRDP programme also included as part of the loanpackage a subsidy which has 25–50 per cent of advance. Asubsidy, like loan forgiveness, is warned against by microcreditexperts, the world over, which was institutionalized in the IRDPscheme. Most practitioners and other experts agree that mixingsubsidies and loans is not a sound practice. However, the shareof government programmes in the small borrowal accounts(SBAs) of commercial banks, has increased by 15 per cent inamount outstanding between 1993 and 1997 (Nair 2000).

IRDP alone created over 40 million defaulters and nearlyone million cynical bankers. It led to the inevitable — loanwaiver by the central government in 1989 under the Agricultureand Rural Debt Relief Scheme. The massive failure of IRDPand its allied programmes forced the government to overhauland restructure them. The central government came up witha new holistic self-employment programme called SwarnjayantiGram Swarojgar Yoja (YGSY) which was launched on 1 April1999, replacing all the earlier self-employment programmes.

3.1.2 Priority Sector LendingAfter bank nationalization the vast banking system apparatuswas used to advance credit to the rural population and func-tioned as the conduit for poverty alleviation schemes under theFive Year Plans and the IRDP. The RBI’s stipulation that atleast 40 per cent of the bank advances must be made towardsthe so-called priority sectors was important in two very different


ways. Firstly, the developmental goals of the government andits intention to use the banks to achieve those goals were maderealizable that is the bank had to function beyond its ‘typical’role, in a development oriented capacity. Secondly, by specifyingthe amounts to be lent to the priority sectors (18 per cent foragriculture, 10 per cent for the weaker sections and so on), thedecision making powers of the bank were severely curtailed.Consequently, the bank while doing directed lending, aimed tomeet targets in terms of amounts advanced against guidelinesstipulated by the RBI. The Agricultural Credit Review Com-mittee states in its report that, ‘They [Commercial Bank man-agers] have been reduced to the position of mere instrumentsto carry out the instructions of governmental functionaries atthe local level’ (1993).

3.1.3 Regional Rural Banks and the outreach of formal institutions

Financial services in the rural sector are provided mainly byaround 33,000 branches of the commercial banks and the 196RRBs. The Banking Commission felt the need for a specializednetwork of bank branches to cater to the needs of the rural sectorand subsequently the GoI in 1975 instituted the Regional RuralBank. The performance of these banks has been dismal but partlydue to political pressure, the RRBs and commercial banks arelikely to maintain their position in the rural credit scene. TheUnion Budget Speech of 2000 stated that: ‘Due to our efforts atrecapitalizing RRBs, 158 RRBs are posting operating profits.Out of these 48 RRBs have been able to wipe out their accumu-lated losses. In view of the importance of the RRBs in ruralfinancing, we will continue with this programme of strengthen-ing the RRBs.’ Despite the decision to support the RRBs, thefundamental problem of the mechanism of disbursement, loanand subsidy made by the RRBs is not addressed at all.

3.1.4 Causes of poor performance of RRBs and commercial banks

The question arises whether the planned system of rural credit


alone has contributed to the existing performance or therewere other factors that contributed to the poor performanceof commercial banks and RRBs in the rural sector? Threefactors requiring consideration are: (a) The bankers from com-mercial banks probably did not perceive the rural agriculturalsector as a bankable segment of society which is substantiatedby the percentage of funds advanced to agriculture over 1985–95. In 1985 over half the credit in rural areas wa given toagriculture. A decade later after the economic crisis when thebanks had to perform and mindful of fiscal prudence, theamount advanced to agriculture was around 11 per cent (Nair2000). Similarly the total amount outstanding in SBA accountsdecreased from 19.8 per cent of total amounts in all accountsto 14.2 per cent. Such significant declines suggest that thecommercial bankers did not consider agriculture as a profitablebusiness for them. Therefore, bankers by training and mind-set, are as yet not capable of managing investments in ruralareas. (b) The process of personnel recruitment in the RRBs,devised to address the needs of rural areas did not give expectedresults. The RRBs hired a lot of their personnel from ruralareas under the assumption that rural people are much moreattuned to the needs of people in their regions. The qualityof the recruits did not match with other bankers and were notcompetent bankers and managers. According to some bankersdespite a pay scale which was on par with the well-trainedurban bankers; absence of or few transfers and lower cost ofliving unlike their urban counterparts, the local people re-cruited at the RRBs were equally apathetic to the issues ofrural credit and poverty alleviation as were the commercialbankers. (c) Politicians periodically ran what were known as‘loan melas’ — waiving debts for political gain and votes duringelection. The local politicians and relatively well-to-do in therural areas appropriated funds set aside for the marginalizedsegments of the rural population. The politicians acquiredleverage as these were government administered programmes.Fortunately, open loan melas do not happen anymore, but thedamage they have done to credit discipline is lasting and is


yet another hindrance that MFIs face while conducting theirbusiness in rural areas.

3.1.5 NABARD and SHG-bank linkage programmesIn 1992, NABARD issued policy guidelines for bank linkageswith Self Help Groups (SHGs). Bank managers were initiallyreluctant to use the new lending technology that is, the useof joint liability groups (which is the status of SHGs in themicrocredit context) instead of collateral for the loans. Thisprogramme has so far been very successful mainly due topromotion of these SHGs by many NGOs. The formation ofSHGs is a difficult and costly task requiring intensive effortsin identifying groups of people with common interests andsubsequent training of these groups. The cost of group for-mation has thus far been subsidized by the NGOs throughtheir grants which in the future should be worked into theoverall transaction cost. However, NABARD is likely to linkas many as 50,000 SHGs to banks this year.

The Union Budget Speech of 2000 highlights another dis-turbing trend in the government policy. NABARD and SmallIndustrial Development Bank of India (SIDBI) which set tar-gets for government agencies in SHG coverage have to coveran additional 100,000 SHGs in the year 2000–2001 despite thefact that group formation is not an easy task. Experience ofbanks shows that in one of the Gramin Banks where the man-agers were motivated to form groups, a total of 15 groups wereformed (seven by managers and the rest by other staff). Of the15 that were formed, six were already defunct (Srinivasan andSatish 2000). None of the bank staff had experience in groupformation and formed ideas on group formation from the cir-cular issued by the Head Office and periodical discussions withthe officials at the Head Office.

A recent development is the formation of groups by DistrictCollectors. It is unlikely that civil servants are trained tooperate at grass-root levels in the manner of NGOs hence thefailure rates in those groups is likely to be on par with thegroups formed by bank branch managers. Target setting for


government agencies reflects policy orientation at the Centrewhich does not specify amounts to be disbursed to varioussectors, and instead specifies the number of borrowing groupsand does not address the incentive structure for bankers.

Some of the confusion in the government regarding policyis reflected in some ways in the structure of NABARD andSIDBI. NABARD is an apex organization with two duties ofsupervising the banks and co-operatives providing rural financialservices, and functioning as a refinance institution responsiblefor promoting microfinance. The obvious conflict of interestbetween the two responsibilities is heightened when targetshave to be met, thereby exacerbating the ‘identity crisis’ facedby NABARD. As NABARD lacks adequate manpower forbuilding the capacity of SHGs the enormous amount of fundsheld by it, have largely remained unutilized since the last fouryears.

3.2 Co-operatives 3.2.1 Government control of co-operativesIn India, formal rural credit and its regulation, beyond the failedlaws enacted for taccavi 1 loans to farmers, began with the es-tablishment of Co-operative Societies Act in 1904. But even adecade before that, societies were established which put intopractice the principles of cooperation and mutual benefit. Fromthe late 1890s to the late 1950s, co-operatives were the mainformal source of credit to the rural poor. Co-operatives duringthe pre-Independence era, were in many ways an extension ofthe government. Interference from the government diluted thegoverning principles of the co-operatives. In 1928 the RoyalCommission on Agriculture recommended the expansion ofrural credit with state patronage using co-operatives as conduitfor credit. Furthermore, the principles of ‘one-member one-vote’ and mutuality were corroded as co-operatives were usedby stronger members to misuse the co-operative for personal

1. Introduced by the British in 1793 for ensuring stability in revenue collec-tion for farmers and subordinate tenants.


gain leading inevitably to malfunctioning co-operatives andfinally in 1945, to the recommendation of the liquidation ofassets of the co-operatives by the Agricultural Finance sub-committee. A decline in the faith in a co-operative damagedcredit discipline. To make matters worse, the co-operativeswere protected from competition. These problems of moralhazard often cited in economic literature prominently figurein issues of regulation.

The Post-Independence scenario was no better with the AllIndia Rural Credit Survey in 1954 recommending majorityparticipation at all levels by the state in co-operatives. Stateintervention caused the same problems as before and added afew more in the post-Independence era. In places like TamilNadu, the co-operative functioned as a source of illicit fundingfor politicians at many levels. Currently approximately 94,000co-operative outlets exist either in the form of branches orvillage level societies under the supervisory authority ofNABARD. In addition, the Rotating Savings and Credit Asso-ciations (ROSCAs), Chit Funds, Nidhis and other ‘informal’means of obtaining financial services, imply that the amount ofcredit extended and savings mobilized should be huge but anenormous gap continues to exist in the demand and supply forthe same financial services.

3.2.2 Mutually Aided Co-operative Societies (MACS) ActOnly in the post-liberalization era, when the Khusro Commit-tee in 1991 recommended a less interventionist and more mar-ket-oriented approach for co-operatives and when the BrahmPrakash Committee in 1991 advocated a model Co-operativeSocieties Act, was there relief in the sad history of the Indianco-operative movement.

This study does not consider the variations among states andother intricacies of the system, which have an impact on themodels implemented in various regions. Andhra Pradesh en-acted the Mutually Aided Co-operative Societies (MACS) Act in1995. Co-operatives formed under this act are largely immunefrom government intervention and a number of co-operatives


have been formed under this Act. While in neighbouring TamilNadu, the co-operative act allows for a great deal of governmentintervention. The co-operative cannot even enact its own bye-laws and must adopt bye-laws given by the state of Tamil Naduwhich were formulated in pre-Independent India where theco-operative was an extension and victim of the government. Inaddition Tamil Nadu has its own Societies Act which gives thegovernment the power, under certain circumstances, to takecontrol of an organization registered under the Act. Hence inTamil Nadu, the co-operative movement is naturally not asrobust as it is in Andhra Pradesh. Some prominent MFIs haveadopted variants of the Grameen model for lack of satisfactoryalternatives.

Following Andhra Pradesh, three states — Bihar, MadhyaPradesh and Jammu & Kashmir, have enacted similar MACSActs. However, they are considered by many to be weaker formsof the Andhra Pradesh MACS Act. Far fewer co-operatives havebeen formed in these states as compared to Andhra Pradesh.Registering under a particular Act is only one aspect of regula-tion. Issues requiring attention are whether the act of registra-tion in itself prevents anomalies from occurring in the financialsystem and does the MACS Act in itself guarantee that theco-operatives will function properly? While recognizing thedifferent characteristics of thrift co-operatives and consumerco-operatives (just as the characteristics of banks and manufac-turing businesses are different) they certainly should not comeunder a similar regulatory regime. This argument is based on theprinciple of regulating the activity and not the institutional form.

3.2.3 Is an enlightened Co-operative Act sufficient for ensuring stability of the financial system?

The MACS Act lays down rules of conduct between the mem-bers of a co-operative and the member–board and specifies therules of conduct between the co-operative and the externalworld. A co-operative registered under this Act has to reportall transactions to the Registrar of Co-operatives. For an aver-age co-operative, several thousand transactions may have to be


reported. In terms of reporting then, the co-operative in Indiais not given the same privileges as a microfinance institution.The reason for this is clear — a co-operative should be fundingitself through the deposits that it mobilizes. Given the largenumber of thrift co-operatives that are being formed, the ideathat the Registrar of Co-operatives or NABARD are able toproperly supervise them is not credible. The Income Tax De-partment and the Home Ministry (under FCRA) will be effec-tive to a certain extent only as ‘supervisory’ authorities. Whileco-operatives developed with the help of an institution like theCo-operative Development Foundation in Andhra Pradesh willbe functioning well, they will not constitute the majority ofco-operatives in the state. With the emergence of appropriateincentives, it might be a matter of time before politician con-trolled MACS emerge.

Lack of proper regulation has been blamed for many of theills afflicting the banking system in India. It is not the lack ofadequate regulation but the ex-post control nature of the legalsystem posing problems for the banking system. Numerouslaws govern all aspects of organizations and strictly prescribethe relationships between the members of the organization, therelationship between the members and the governing body, thegoverning body and other external bodies. The legal system isex-post control. Once fraudulent behaviour has occurred, thereis recourse to the legal system. Perpetrators might be caughtand punished. The poor often do not have adequate access tothe judicial process and when they do the process can take along time making the fight worthless and expensive to prose-cute perpetrators.

The guiding principle of regulation is the provision of anenvironment where there is no distortion of competition. Un-fortunately, the distortions introduced into the microfinancesector in the process of implementing government policy, withall good intentions, have been enormous. There is no dearthof regulation in India — there are laws for every conceivableeventuality and regulation for a vast array of institutional forms.The state of Indian banks is testament to the damage done by


the confusion between policy and regulation. Governmentregulation is particularly not appropriate for the Indian micro-finance sector but the aims and principles of regulation asoutlined earlier are necessary for the survival of the financialsector, and available alternatives need to be considered to en-sure the continued and sustainable functioning of microfinancein India.


4

Microfinance Services in India

4.1 IntroductionThe share of supply of credit to rural areas through institu-tional sources has increased substantially since 1971. The AllIndia Debt and Investment Survey (AIDIS) (1991) shows thatout of the total credit supplied to rural households, nearly 64per cent were met by institutional sources as against approxi-mately 30 per cent in 1971. Despite the fact that over theyears there has been an increase in overall outreach and ab-solute disbursement of institutional sources, since 1990 therehas been deceleration in the growth of bank credit to ruralareas. The share of rural credit in total credit disbursed byscheduled commercial banks was about 3.5 per cent in 1971,which steadily grew up to 15 per cent over the two decades.After 1990, the share of rural credit declined steadily droppingdown to 11 per cent the end of 1998. Between 1991 and 1993,the share of bank credit to rural households went up by 22per cent when compared to the rise of 40 per cent and 52 percent to the private and public corporate sector respectively(EPW 1997; RBI 1998).

This decline in the share of rural credit has been coupledwith the increase in the absolute number of poor householdsin the country. Estimated at 75 million, the total credit usageof these households (Rs 6,000 for urban households andRs 4,500 for rural households) works out to a staggeringRs 45,000 crores demand which has led to the emergence ofmany new institutional forms.

4.2 The Task Force on Microfinance Regulation The increase in the number of NGO–MFIs, which borrowfunds for on-lending and possess loan portfolios of more thana million Indian Rupees, has posed the challenge of estab-lishing a framework signalling the stability of the market andthe provision of service. Hence a National Task Force onSupportive Policy and Regulatory Framework for Microfi-nance (NABARD 1999) (Task Force), was established whichclosely examined four main issues relating to: (i) the main-streaming of NGOs and other emerging institutions; (ii) theregulation and supervision of these bodies; (iii) organizationalfeatures; and (iv) requirements to increase capacity for growthand service.

On the specific issues of the emerging diversity in mi-crofinance, the Task Force recommended establishing thresh-olds for different functional roles undertaken by NGOs.The following broad categories and recommended thresholdsare:

1. MFIs purveying credit only;2. MFIs purveying credit and mobilizing savings from the

clients/loanees (below cut-off limit of Rs 2 lakhs); 3. MFIs purveying credit and mobilizing savings from the

clients/loanees (above cut-off limit between Rs 2–25lakhs); and (10 per cent reserve requirement in the formof bank deposit and rising to 15 per cent as and whenthe deposits go past the Rs 25 lakh ceiling);

4. MFIs purveying credit and mobilizing savings from theclients/loanees and general public.

Though the RBI has not made specific announcementson business volumes and thresholds it has made other legaland operational policy pronouncements. Microfinance agen-cies can develop products with banks — credit and savings,at rates and terms acceptable to both parties, irrespective oflegal form of the promoting microfinance agencies (RPCD.No. PL.BC. 62/04.09.01/99–2000 dated 18 February 2000).


(Annexure 2). The RBI has also exempted the not-for-profitcompany, (Sec 25) (DNBS. 138/CGM (VSNM) dated 13January 2000) (Annexure 3) providing micro-credit from ful-filling NBFC norms, provided they do not mobilize deposits.By expressing its neutrality to any form of organization andfocussing on the activity, the RBI has indicated the direction,which it will possibly take to build its microfinance framework.

4.3 Emerging Microfinance Institutions in IndiaIn recognition of the demand for financial services among thepoor, over the past few years (MFIs) have evolved systems thatallow for the poor to receive credit supply. Today, this pro-vision of credit and other services is reaching a critical sizeforcing NGO-MFIs to take new forms and establish newlinkages.

4.3.1 Legal Forms of MFIsThese new MFIs can be broadly divided into three categorieson the basis of the legal form adopted by them:

1. Not for Profit MFIs such as societies registered underSocieties Registration Act, 1860 or similar State Acts;Public Trusts registered under the Public Trust Act,1882, and Section 25 companies of the Companies Act,1956;

2. Mutual Benefit MFIs include co-operative societies reg-istered under the Co-operative Societies Act of the re-spective state or the central Multi-State Co-operativeAct, 1984; Mutual Benefit Trusts or Nidhis under Sec620 of the Companies Act, 1956; and

3. For Profit MFIs that includes NBFCs registered underthe Company Act, 1956 (Mahajan et al 2000).

Among these forms of organizations, only NBFCs and Co-operative banks are regulated by RBI as financial intermediarieswhile the rest are de facto financial intermediaries requiringminimal regulatory compliance.

Microfínance Services in India 23

4.3.2 Operating Models of Retail MFIsIrrespective of their legal form, the retail MFIs in India haveadopted a wide spectrum of operating models of which the mostprominent are (adapted from Arunachalam 1999):

1. The Self Help Group (SHG) model: SHGs tend to behomogeneous in nature (either caste, occupational orregional). The SHG lends money to its members bothfrom members’ savings as well as money mobilized fromexternal sources. NGOs mobilize clients into SHGs andprovide savings and credit services. Linkages with thelocal banks are also arranged for credit purposes.

2. The Federated SHG model: SHGs are federated into aninstitution in any of the following ways:

(a) SHGs are registered as co-operatives in states wherean enabling co-operative environment exists.

(b) Some small SHGs operate as solidarity groups byadapting the Grameen model and in turn are feder-ated into large co-operatives.

(c) Within this broad structure there can be many op-erating variations depending on the strategy of thepromoting NGOs and the juncture at which theyopen and manage bank accounts.

3. Urban Co-operative Bank model: Direct lending to cli-ents in urban areas through an Urban Co-operativeBank. Two prominent examples are the SEWA Bank inAhmedabad and the Cuttack Urban Co-operative Bankin Orissa.

4. Trade based group model: The establishment of a struc-ture which manages ‘typically industrial’ activity, and

5. The eclectic NBFC model.

4.4 State Regulated Microfinance IntermediariesThere are very few regulated microfinance intermediaries inthe country. Institutions in this category are (NBFCs) andCo-oper-ative Banks who have to comply with and fulfil the


stipulated regulatory requirements. The limitation of the ex-isting regulation is that it does not take into considerationportfolio related characteristics arising from microfinance re-lated services with the result that compliance is high cost andrestrictive.

4.4.1 NBFCsNBFCs are registered under the Companies Act, 1956 andregulated by RBI. Under the RBI (Amendment) Act, 1997, itis mandatory for NBFCs to get a Certificate of Registrationfrom RBI, which is granted only if a NBFC has a minimumNet Owned Fund (NOF) of Rs 25 lakhs and for a new NBFC,Rs 2 crores. To protect the interests of depositors, the RBI hasintroduced strict regulations for NBFCs such as the mainte-nance of a minimum standard of NBFC, rating by approvedrating agencies, capital adequacy and liquid assets as prescribedby RBI. The prominent NBFCs who also work among the poorare BASIX, Hyderabad; Sarva Jana Seva Kosh, Chennai; Sang-hamitra, Bangalore; SHARE Microfin Ltd, Hyderabad; CFTS,Mirzapur (UP); Indian Association of Savings and Credit(ISAC), Marthandam, Tamil Nadu.

4.4.2 Co-operative Banks In the co-operative banking segment engaged in microfinanceamong the poor, in addition to the SEWA Bank, Ahmedabad,the latest entrant is the Cuttack Urban Co-operative Bank.The SEWA Bank is registered as co-operative society withbanking license from the RBI. SEWA Bank started with 4,000shareholding members in 1974 and by the end of 1998 it hadmore than 26,000 shareholders. The total loans outstandingin 1998 were about Rs 86.6 million and total deposits wereRs 171 million. Although as a bank, a co-operative bank hasmany advantages over NBFCs, the dual control of Registrarof Co-operatives (ROC) and the RBI has in many ways re-stricted these institutions in achieving their full potential. Itis now time to remove the unnecessary control of the ROCor alternatively the ROC regulates only the institutional aspect


of the co-operative bank while the RBI regulates the functionalaspect. The committee under Deputy Governor, RBI, JagdishKapoor to suggest measures to strengthen the co-operativebanking movement in India submitted its report in July 2000,in which several legislative reforms to strengthen co-op bankswere suggested. The recommendations of the committee areyet to be accepted.

4.5 Unregulated Microfinance IntermediariesMany financially unregulated entities provide microfinance ser-vices, whose important features are delineated in this section.

4.5.1 NGO-MFIsRegistered as Societies or Trust Acts or Section 25 Companies,the entire swathe of NGO-MFIs choose to function as one ofthe following:

1. Specialized Service Providers — These institutions are ex-clusively working as MFIs, with a minimal provision ofother services such as health or education. The domi-nating framework in the establishment of policy and theinvestment of resources is determined by the need toprovide efficient services. Within this category, thereexist two sub categories, (a) one which provide retailMicrofinance services like savings, lending money etc.to the poor, especially their members and raise fundsfrom members and other financial institutions, (b) onewhich function as Microfinance Wholesalers or ApexBodies, giving financial support to the smaller institu-tions (retailers) providing Microfinance services.

2. Multi-service Providers — In the Indian scenario, a largenumber of NGOs registered either as societies or trustshave taken up Microfinance services as an extension oftheir community development programmes like provid-ing health services, education, income generation, envi-ronment etc. In this case microfinance is either bundledwith existing social intervention or occupies a position


equal to or less than the dominance of other program-mes.

4.5.1.1 Retail NGO-MFIsDuring the last decade retail NGO-MFIs have come to domi-nate the retail service landscape with the most widely practisedservice model being the SHG. Most of the retail NGO-MFIschoose to either get credit linkages established through localbranches of banks or get credited directly to later on-lend thefunds to SHGs. During the year ending March 2000, retailNGO-MFIs had linked more than 80,000 SHGs under theNABARD SHG-Bank Linkage Programme that is, nearly 86per cent of the total groups linked under this programme (SeeTable 4.1). During the same period in 1998, the total numberof SHGs linked through NGOs was 11,595, which constitutednearly 81 per cent of the total SHGs linked. These figuresdepict not only the huge growth in number of SHGs linkedbut also the substantial increase in NGO involvement over theyears. From 220 NGOs involved in this program in 1996–97,the figure has dramatically gone up to 718 in 1999–2000.

Table 4.1: NABARD’s Bank-SHG Linkage Programme

Particulars Cumulative as on

March1997

March1998

March1999

March2000

No. of SHGs linkedduring the year

3,841 5,719 18,678 81,780

Total no. of SHGslinked

8,598 14,317 32,995 114,775

Total no. of NGOsinvolved

220 291 550 718

Total Bank Loans (inRs million)

118.36 237.60 570.70 1,929.82

Total Refinance (inRs million)

106.6 213.80 520.60 1,501.26


Particulars Cumulative as on

March1997

March1998

March1999

March2000

Total no. of particip-ating banks

120 150 202 266

Total no. of familiesassisted (in million)

0.15 0.24 0.56 1.90

Average loan/SHG(in Rs)

13,766 16,596 17,297 16,814

Average loan/Family(in Rs)

810 978 1,019 1,016

Model-wise linkage of SHGs (in %)Bank-SHG-Members 13 18 17 14Bank-NGO (Facilitator)-Members

45 46 56 70

Bank-NGO (Fin.Intmd.)-SHG-Members

42 36 27 16

Source: NABARD & microFinance, 1999–2000. Similarly, SIDBI has also launched its Micro-credit Scheme

(MCS) in February 1994 to assist individual poor or SHGswith micro-enterprise programme through NGOs. The quan-tum of minimum loan to a NGO is Rs 10 lakhs with an interestrate of 9 per cent per annum, repayable within five years. Ason 31 March 1999, SIDBI had sanctioned loans to the tuneof Rs 29.42 crores to 142 NGOs in 24 states, benefiting2,06,000 poor.

4.5.1.2 SHG FederationsThe several forms of SHG federations make it difficult toclassify their operating features around one simple model.While we have tried to classify the structure earlier in thissection, there are important variants even within those models.In some SHG federations, the next level from the SHGs is the


cluster, which gathers self-help groups from a geographic unittogether and in turn federates them into a larger unit calledfederations. In some instances the retail services are undertakenby the SHGs, in others by the cluster and in still others by thefederations. The point of service in this structure finally deter-mines the point of interface with the local bank.1 During thepast few years, community-based organizations (CBOs) areemerging which are directly borrowing from either the gov-ernment or non-government on-lenders and are well on theirway to become full-fledged MFIs.2 These variations result fromthe strategic choices the promoting NGOs make in mobilizingthe SHGs (See Box 4.1).

Box 4.1: State Profiles: Maharashtra and Orissa

State Profiles:What is happening in Maharashtra and Orissa?

Given the diversity in the microfinance sector, gen-eralizations are difficult. Across the sector, the oper-ating differences are large, though the commonelement is the multi-service providing profile of mostof the players with only a few specialized service pro-vider organizations. The variations in the sector arehighlighted by the cases of Maharashtra and Orissa.

MaharashtraThe Maharashtra Rural Credit Programme focussedon providing promotional resources for NGOs to linkSHGs to banks. All the organizations were registeredas either Trusts or Societies and have significant de-velopment experience. While 50 per cent of the or-ganizations have a development presence of more than15 years, only 10 per cent of the organizations were

1. Though the co-operative might be the most appropriate organization, thelevel of potential interference by the government makes organizations preferother legal forms. 2. NGOs like PRADAN, MYRADA, ASSEFA, DHAN Foundation, Chai-tanya, Shramik Bharathi, etc. in different parts of the country have promoteda number of SHGs’ Federations.


less than three years old. Further, 50 per cent of theseorganizations possessed a portfolio of at least fiveprogrammes. In addition most of these organizationshad a small geographical coverage of a maximum offive taluks, and 20 per cent worked in more than 20taluks. In terms of outreach 50 per cent of theseorganizations worked with more than 2,500 clientsbut less than 7,000 clients. Invariably all of them have adopted the SHGmethod to make available both savings and credit ser-vices. The average savings per member accounts tobetween Rs 225 and Rs 375 irrespective of clients ororganization experience because savings are returnedto members after every five years and then savingsare restarted. In doing so, only one organization wasdriving the credit programme with savings mobilized,the rest used the revolving fund from the organiza-tion’s own funds, the bank linkage, and finally bor-rowed from an apex institution, such as FWWB,RMK, SIDBI or HFDC. Thirty per cent amongthese NGOs had promoted federations of SHGs toexclusively manage micro-finance activity but noneof them have been registered as a co-operative.

OrissaAll the organizations are registered under the Socie-ties Act of 1860. While 50 per cent organizationshave a development presence of more than 10 years,of which 30 per cent organizations have more than15 years and the rest are 7–10 years old. Further, 60per cent of these organizations possessed a portfolioof at least five programmes. In addition, most of theorganizations have the geographical coverage of lessthan 500 villages and only 20 per cent organizationswork in more than 500 villages. In terms of outreach,32 per cent of these organizations have more than3,000 members and the rest below 3,000 members. Predominantly, SHG model is followed, except ina few cases, where the co-operative approach is adop-ted. The main source for credit operation is savings.About 56 per cent of the states have mobilized savings


of more than Rs 5 lakhs from the members. Othermajor sources for credit operation are bank linkagesand apex institutions.

We believe that over the next few years more efforts needto be focussed on understanding and managing these institu-tions more effectively which will lead to functional claritybetween the NGOs, the federations, and the banks or anyother refinancing arm. We hope that the functional clarity ofdifferent models will stabilize resulting in a better under-standing about the nature of entity and define the inputsrequired to be a optimal firm providing financial servicesefficiently, and intermediating for its clients. Only such acondition will make it possible for the development for anyregulatory effort to succeed.

4.5.1.3 Apex InstitutionsFollowing the recommendation of GoI’s Shramshakti report(1988) the GoI established the RMK in March 1993 to accel-erate the flow of credit to the women to support self-employ-ment, particularly to those in the unorganized sector. Thespecific mandate was to ensure the direct supply of credit toNGOs and bypass the arduous bank process. Apart from theregular lending activity, the fund has resources for capacitybuilding. Till 1999, RMK has supported more than 377 NGOswith the disbursement of Rs 45.22 crores to benefit 2,95,000(The Task Force Report 1999).

RGVN, established in April 1990, with corpuses from theIndustrial Finance Corporation of India (IFCI), Industrial De-velopment Bank of India (IDBI) and NABARD aims to improvethe quality of life of the poor or otherwise underprivileged ruraland urban people through social action. It is registered as anon-profit society under Societies Registration Act 1860.RGVN is working as an indigenous donor agency with smallNGOs and CBOs to promote livelihoods for the poorest peoplein economically least developed regions. It has substantial pres-ence in eastern and northeastern part of the country. It is


working with more than 800 NGOs across 13 states. The totalamount disbursed during the decade was more than Rs 10 crorescovering nearly 53,000 families.

FWWB was established in 1982 as an affiliate of Women’sWorld Banking, New York to promote direct participation ofwomen in the economy through access to financial services.Other intermediaries like BASIX, supporting NGOs on-lendingto SHGs and direct assistance to the beneficiaries are also com-ing up to assist poor with the micro-finance services.

4.5.2 MACS A landmark in the history of the Indian co-operative movementwas created when the Government of Andhra Pradesh (AP)enacted the MACS Act in 1995. Subsequently Bihar, MadhyaPradesh and Jammu & Kashmir enacted MACS Act in theirstates while in many states, it is in pipeline.

Co-operatives formed under this act are largely immune fromgovernment interventions in their affairs such as, fund raising,governance etc. Over 2,000 MACS were reportedly registeredin AP recently. According to the CDF, Hyderabad, 234 thriftco-operative societies (with 59,000 rural men and women mem-bers) promoted by CDF were registered in Warangal district ofAP under MACS Act till December 1999. These MACS providesavings, borrowing and loan insurance services to their mem-bers. So far the MACS have mobilized Rs 837 lakhs exclusivelyfrom their members and in 1999, had lent Rs 1,038 lakhs to40,000 members (CDF 1999). In Bihar, out of 667 societiesformed under the Bihar Self Supporting Co-operative SocietiesAct 1996, only 14 of were credit co-operatives (The Link 2000).We believe that this legislative framework will increasingly beutilised by CBOs to develop as financial intermediaries.

4.6 ConclusionThe failure of the state agencies to provide financial servicesto poor has led to the mushrooming of large number of alter-native financial institutions which have addressed bridging of


the wide gap between demand and supply of microfinanceservices. They have designed their operation according to theneeds of the poor customers and demonstrated that even bank-ing with the poor is financially viable. In being responsive theneeds of the poor, many are still innovating the design of thedelivery of the programme which has lead to a large numberof variations in the operating model.

We need to take the next step by understanding the natureof these variations and the causes driving them. While assidu-ously avoiding the dangers of evaluating these models, effortmust be made to understand the minimal possible effort thatwill be required to regulate them. This should serve two pur-poses — one to maintain stability and the other to ensure thatsome of the fly-by-night operators, so prevalent in the countrydo not make an appearance in this sector. Regulation shouldnot serve to limit the growth and presence of genuine andserious players in the market. As per the current trend, the widegap between supply and demand, the growth rate of alternativefinancial institutions will continue to be high in the future.Given the tenuous nature of the balances necessary to maintainit is important that serious attention is paid in establishing theappropriate regulatory context for the microfinance sector.


5

International Experience in Microfinance Regulation

5.1 Different approaches in Microfinance RegulationMicrofinance has been practised around the world in manyforms and by various institutions, ranging from informalROSCAs, NGOs, credit co-operatives, non-bank financial in-stitutions, and commercial banks. The challenge facing regul-ators considering appropriate regulatory approaches iscomplicated by the fact that MFIs range significantly in insti-tutional type, scale of operations, and level of professionalism(Berenbach and Churchill 1997). Given the diversity of eco-nomic and legal environments under which microfinance isprovided, as well as the motivations of actors involved in mi-crofinance, controversy over the manner of regulation andsupervision of microfinance is not surprising. The variety oflegislative proposals, regulatory frameworks, and supervisorypractices the world over reflect this reality (Valenzuela andYoung 1999). Responses to MFIs have ranged from no regu-lation to full external regulation, outlined in Table 5.1.

5.1.1 Initial Steps (No Regulation)Microfinance has generally evolved outside a regulatory frame-work though instances of completely unregulated MFIs arerare, as even NGOs are usually registered with the appropriategovernment authority either as a society, trust, or any otherentity and are usually required to submit a memorandum ofassociation and periodic financial statements to the authority,especially if they are to qualify for favourable tax treatment.

The problem is that such existing mechanisms are neitherenforced vigorously nor driven from the perspective of moni-toring financial intermediary activities. The legal requirementon NGOs does not state whether an NGO is doing a good jobas a financial institution.

Table 5.1: Approaches in Microfinance Regulation

Regulator Supervisor FeaturesInitial steps None None Industry

standardsSelf-regulation Federation

or SROFederation or SRO

Peer pressureto abideincentives/sanctions

Hybrid Statutory body

Third party(federation,accountant,etc.)

Jointappointment

Existing laws Statutory body

Statutory body

Governmentmandate

Special laws Statutory body

Statutory body

Governmentmandate

Source: Adapted from Berenbach and Churchill, 1997.

In some countries, with the maturing of microfinance in-dustry, MFIs have established associations or interest groupsto initiate formalization process. They have initiated a dialoguewith regulators and policy makers to define the appropriateregulatory approach for their environment and supporting theinitiative, they built up databases, defined best practices and,specified industry standards though the adoption of industrystandards is voluntary.

5.1.2 Self-RegulationSelf-regulation occurs where the industry develops its ownsupervisory and governance bodies to enforce the industry

International Experience in Microfinance Regulation 35

standards which has occurred primarily through federations ofcredit unions or co-operatives (Berenbach and Churchill 1997).The industry standards are enforced by a peer pressure to abidewith or without incentive and/or sanction mechanisms such asdeprivation of the ‘stamp of approval’ in case of non-compli-ance with the standards. The incentive for MFIs to collaborateis to signal their success to outsiders and thus lower theirrefinance costs or to gain access to certain refinance facilities.The outsiders are donors, apex organizations, commercial in-vestors, and also retail depositors (Staschen 1999a). In a situ-ation where refinancing funds are plentiful, however, the carrot(future grants or loans or investments) may be an insufficientincentive to motivate high performance (Valenzuela and Young1999). Self-regulation can be supplemented by market-basedsupervision, such as rating services, publication of interest ratesor financial statements. Market-based supervision can be astrong incentive for ensuring good performance among finan-cial institutions, as their business will suffer if public informa-tion shows them to be managing poorly. However, market-based supervision requires public disclosure of verifiable infor-mation in laymen’s terms but is limited in the absence ofenforcing powers that is, it cannot force an institution to closedown immediately (Valenzuela and Young 1999).

In its pure form, self-regulation is rare and is essentially anappraisal tool for investors. If self-regulation is supposed toprotect not only investors but also clients (retail depositors andborrowers), it requires stronger sanction mechanisms. Submis-sion to a SRO can, for example, be prescribed by government,precluding a simple cancellation of membership. The govern-ment can also confer the exclusive right on the SRO to closedown individual MFIs or can exercise direct influence on theSRO whether through its provision of funds or control overbusiness activity. Self-regulation without government participa-tion suffers from credibility problems if there are several rivalcompetitive regulatory approaches. It can, however, serve as atemporary second best solution if the microfinance sector isaccorded low priority by the government which is not interested


in getting involved in regulation. Self-regulation can preparethe way for government institutions to participate in or takeover supervision (Staschen 1999a and b).

5.1.3 The hybrid approachIn the hybrid approach, the regulatory authority maintains legalauthority over the supervised institutions either through theexisting legal framework or a special microfinance law butdelegates supervisory responsibilities to a third party, such asan MFI federation or an independent technical entity (Christenand Rosenberg 1999). The hybrid approach is logical since thesupervision of microfinance portfolios requires different ap-proaches and different sets of skills than supervising commer-cial banks. As the value of microfinance portfolios is signi-ficantly smaller than those of traditional banks, and poses lessof a threat to the stability of the financial system, it is under-standable that banking supervisors would be willing to delegateresponsibility for monitoring their performance. In addition,because most countries do not have a critical mass of MFIs toform a peer group, it may be useful to involve third-parties whocan compare MFIs on a regional or international basis. Animportant drawback of the hybrid approach is that in the longrun it does not build internal capacity in the superintendencyto monitor microfinance (Berenbach and Churchill 1997).

The hybrid approach is being practised in Indonesia, wherethe Bank Rakyat Indonesia has used its rural branch offices tosupervise a large number of municipal banks on behalf of thecentral bank. In Peru, the bank superintendent has delegatedday-to-day oversight to a federation of municipal savings andloan institutions called FEPCMAC. South Africa’s Micro Fi-nance Regulatory Council is a unique case of a self regulatoryregime evolving into a hybrid system of regulation (discussedin section 5.2.3).

5.1.4 Existing lawDeveloping commercially-oriented microfinance under exist-ing laws is feasible in most countries that have fairly well


developed banking legislation. An approach that has workedfor a number of NGO institutions seeking to acquire therights and privileges of a regulated financial institution isthe transformation into an institutional form by adapting tothe current banking laws. For example, in the early 1990s,PRODEM of Bolivia and Corposol of Colombia both NGOs,spawned regulated financial intermediaries — a commercialbank (BancoSol) and a finance company (Finansol) to providemicrofinance services. K-Rep, an NGO in Kenya, has recentlyobtained a commercial bank license. In the Philippines, TSPIDevelopment Corporation has submitted an application toestablish a thrift bank, while the Bangladesh Rural Advance-ment Committee (BRAC) is preparing to spin off its financialservices to a BRAC owned commercial bank (Berenbach andChurchill 1997).

Since the mid 1990s, a number of commercial banks andfinance companies seeking to expand their market nicheshave decided to create specialized microfinance divisionswithin their existing institutions. Some of the banks areBanque de l’Union Haitienne in Haiti, Banco Economicoin Bolivia, Banco de Desarrollo in Chile, National Devel-opment Bank of Egypt, Hatton National Bank in Sri Lanka,and the Commercial Bank of Zimbabwe (Valenzuela andYoung 1999). In many cases, specific aspects of the existingregulations and supervisory practices were not appropriatefor microfinance operations necessitating the working to-gether and educating each other of regulators and bankersin order to make the needed adjustments (Valenzuela andYoung 1999). Adjustments pertained to interest rate caps,limits on unsecured lending, requirements for branches, loandocumentation regulations, registration of collateral, limitson guarantors or co-debtors, daily reporting requirements,and so forth. Such regulation by exception can be abused,but appears to be the most efficient response to a transitionalsituation where new types of finance are coming into a market.Eventually, banking regulations need to be changed to ac-commodate new microfinance methodologies, whether or not


a country creates a special license for new MFIs (Christenand Rosenberg 1999).

5.1.5 Special lawWhile recent financial sector reforms in many countries havetended towards eliminating special banking categories andmoving towards universal banking, interest has emerged indeveloping specialized MFI licenses regulated by governmentauthorities. Many African and Central American countries, inparticular, are currently in the midst of such policy reformprocesses. Nepal, Morocco, Ethiopia, Peru, and Gambia areexamples of countries that have already passed a specialized lawfor the creation of regulated MFIs. Countries in the process ofrevising draft laws include Uganda, Zambia, Honduras, ElSalvador, Bosnia, and Brazil (Valenzuela and Young 1999). AsMFIs differ from other financial institutions for regulatingMFIs, it is possible to either make exceptions within the existingregulatory framework or to create a special law that is appro-priate to the unique characteristics of MFIs. A special microf-inance law would have the following advantages anddisadvantages:

Advantages

• The primary advantage of creating a special category isto authorize institutions to provide a reduced range offinancial services, without becoming a bank, in exchangefor a lower capital requirement. This permits an MFIto pursue its goals, but bars its entry into complex serv-ices for which the institution may not be well prepared.

• A special category allows MFIs to maintain their distinctcharacteristic and effectively serve their target market.A category of financial institutions designed for specificfeatures of low income communities links the informalsector and the mainstream economy.

• By creating a special category for MFIs, regulatorsheighten the visibility of the microfinance sector. Thiswill attract attention and create interest in forming new


financial institutions. A special category can also encour-age NGO MFIs to think seriously about self-sufficiency.

Disadvantages

• The argument against a special microfinance law is thatin most countries a variety of institutional forms existthat can be (and are being) adapted to serve microfinanceclients. Instituting new institutional categories with lowminimum capital requirements only serves to burden thesuperintendencies (Valenzuela and Young 1999).

• A specialized class would also unnecessarily limit thefunctions that the intermediary may want to assume ata later date. Further, a special regulatory category forMFIs may create disincentives for banks to lend to thissector. If banks can be encouraged to serve this market,this method of extending the financial system is less riskyand easier to regulate than encouraging non-profit or-ganizations to create financial institutions (Berenbachand Churchill 1997).

• Opening separate regulatory windows for specializedMFIs is premature in most countries. The fundamentalquestion is whether the country has MFIs that are suit-able for licensing (that is, have the track record of prof-itability and sustainability) but cannot use an existingwindow. The vast majority of NGO-MFIs do not as yetmeet this test. In most countries, shortage of licensableMFIs is the binding constraint to the growth of microf-inance, rather than the absence of tailor-made regula-tory regime (Christen and Rosenberg 1999).

Countries that have established a special category, have notyet attained sufficient experience to assess whether effectivelydepth has been added to the financial system without weaken-ing it. It is also too early to tell if the supervisory bodies willhave the resources to effectively monitor these new institutions,or whether they will develop alternative ways of supervisingMFIs (Berenbach and Churchill 1997).


5.2 Specific experiences with different approachesAlthough the global experience of microfinance regulation isnot yet rich to assess which approach is better than another,there are a number of well-known initiatives in Table 5.2.

Table 5.2: Initiatives in different approaches

Formal MFIs Informal MFIs

Initial steps N.A. The Coalition inthe Philippines

Self-regulation Credit unions and co-operatives world-wide;A rating agency forcredit unions inGuatemala

MLA in SouthAfrica

Hybrid BRI for Village CreditBoards in Indonesia;FEPCMAC for CMACs(mutual banks) in Peru

MFRC in SouthAfrica

Existing laws Commercial banksworld-wide;BancoSol in Bolivia;Finansol in Colombia;K-Rep in Kenya;TSPI in the Philippines;BRAC in Bangladesh;NBFCs and LABs inIndia

N.A.

Special laws Grameen Bank inBangladesh;PFFs in Bolivia;CMACs andEDPYMEs in Peru;The Mutualist Law inWest Africa

N.A.

Source: Adapted from Berenbach and Churchill, 1997.


5.2.1 Initial Steps: Philippine Coalition for Microfinance Standards

In Philippines, most MFIs are co-operatives and NGOs. Com-pared to co-operatives, which are regulated and possess a setof financial and performance standards, NGOs operate outsidethe formal financial system. While NGO informality is anelement in their relative success in reaching the lower-incomesegments of society, most NGO MFIs are characterized bymarginal outreach and lower absorptive capacities which isattributed to the lack of common standards. The People’sCredit and Finance Corporation was established as an apexmicrofinance lending institution, and banks were willing tolend to NGOs. These wholesale lenders need mechanisms toappraise MFIs and to monitor their performance. Therefore,a two-year project was started in 1996 to establish performancestandards. A tactical coalition, called the Philippine Coalitionfor Microfinance Standards, was formed with representativesfrom NGO MFIs, the supervision unit of the Central Bank,People’s Credit and Finance Corporation, commercial banks,other governmental planning and regulatory bodies, privatefoundations, academic and research organizations, and donoragencies. The project’s expected five outcomes are:

1. create a rich database on the state of microfinance in thecountry;

2. establish a set of performance standards developed andaccepted by the members;

3. produce a collection of best practices; 4. Training and assistance of select NGO MFIs to improve

their support systems to scale up and move towardsviability; and

5. influence the national policy and regulatory agencies onstandards and specific reforms working towards a favour-able regulatory environment for microfinance.

The project is working towards developing a capacitymeasurement system to identify the strengths and weaknesses


of individual MFIs, which implies the evolving of a ratingsystem.

Since the coalition is not a formal, legal organization buta tactical alliance of various autonomous organizations witha common objective, it is not clear how the coalition willseek to ensure that MFIs comply with the standards. Thecoalition has the options of creating an apex body (SRO)covering all major MFIs; backing the standards with someform of incentives or sanctions, through the legal system orthrough the policies of a second tier institution. The coalitionmay put in place a system involving accreditation of NGOs;reporting and validation, and rewards or penalties for com-pliance or non-compliance. Another question that remainsas yet unsettled is the problem of governance structure inan NGO due to lack of ownership and the consequencesfor the safety of deposits.

The coalition’s impact on the Philippine microfinance sec-tor is yet to be seen, though it is a good precedent for IndianMFIs and possibly the NABARD Task Force which couldevolve into a similar organization.

5.2.2 Self-Regulation: Credit Unions and Co-operativesOutside credit unions and co-operatives, self-regulation in itspure form is rarely seen. The Philippine Coalition for Micro-finance Standards is moving towards a self-regulatory regime,but its location on the self-regulation and hybrid approachcontinuum is as yet not known.

At present in Guatemala, 13 strong credit unions repre-senting 85 per cent of the country’s credit union savings andloans are setting up a private rating agency. Public confidencein credit unions is so low that they have to pay 2 per cent morethan the banks they compete with to raise deposits. The coun-try’s financial authorities have refused to take responsibility forsupervising credit unions hence as a temporary measure, aprivate alternative is being attempted. The principal sanctionfor a non-complying credit union will be the revocation of thecredit union’s plaque. Additional sanctions include the right of


the rating agency to replace the boards or management of theparticipating credit unions in the event of non-compliance. Itis conjectured that the enforcement of the rights would prob-ably take too long to be practical. The participants hope thatas the rating agency gains credibility, the government authoritywill eventually agree to have the bank superintendency super-vise the stronger credit unions, and perhaps use the ratingagency in a scheme of delegated supervision though implemen-tation is yet to begin (Christen and Rosenberg 1999).

5.2.3 Hybrid approach: Microfinance Regulatory Council in South Africa

The South African microfinance sector experience is uniquewhere a self-regulatory regime of MFIs over time has evolvedinto a hybrid system. MFIs in South Africa mostly providecredit services due to widespread availability of savings servicesby postal savings banks and commercial banks. Funding sourcesfor MFIs are borrowings from banks and other financial insti-tutions which limit their outreach due to very high interestrates of the banks thereby making the development financeinstitutions as the main source. In addition, MFIs face twoproblems: (i) MFIs are prohibited by the Banking Act fromtaking wholesale funding, and (ii) the Department of Tradeand Industry (DTI) wants to revoke the exemption from theusury act for small loans.

The Micro Lenders Association (MLA), one of the twonetworks of MFIs, started a self-regulatory system with a codeof conduct and a disciplinary committee to solve the problems.Simultaneously, two development financial institutions, KhulaEnterprise Finance Limited and the National Housing FinanceCorporation (NHFC), commissioned a study to explore a hy-brid system of microfinance regulation. As apex organizations,they recognized the need for regulation in the microfinancesector but wanted to delegate the supervisory tasks to an inde-pendent party. For Khula and NHFC to act as regulator andsupervisor would result in conflict of interest because at thesame time they would be both players and referees. The two


institutions appointed an Advisory Panel composed of MFIs,institutional investors, DTI, South African Reserve Bank(SARB), the Institute of Chartered Accountants, and so forth.In 1997 the Advisory Panel submitted a detailed proposal onhybrid regulation.

Although SARB and DTI were involved from the outset,they did not initially show interest in the Advisory Panel’sproposal. With the proposal shelved, the Alliance of Micro-Enterprise Development Practitioners (AMEDP), the otherMFI network, began establishing its own system of self-regu-lation without involving the state supervisory institutions andcommissioned consultants to adapt the Advisory Panel’s pro-posal. In 1998, SARB and DTI finally agreed to the proposal.As a result, the Micro Finance Regulatory Council (MFRC)was set up involving MLA, AMEDP, Khula, NHFC, and arepresentative each from SARB and DTI. MFRC is empow-ered to impose sanctions on infringements of its regulations,including prohibition of further business activity. At the sametime, access to wholesale deposits and exemption from theusury act are made conditional upon membership to MFRC.An arrangement is created where a large part of reg- ulatoryresponsibility is delegated to a private institution with suffi-cient power of sanction to confer credibility on this hybridregulation due to participation by the government supervisoryauthority.

The South African experience represents the most advancedself-regulatory/hybrid regime for NGO MFIs to date and de-serves praise even if MFRC operating under the existing lawmay not be the best approach. According to Staschen (1999aand b), the practice to date in South Africa of adopting lawsand then exempting certain institutions from the provisionswould appear inadvisable. As a consequence only conditions ofexemption apply instead of detailed provisions in the laws.Drafting a separate law could prevent further fragmentation ofthe regulatory framework, improve its transparency, and allowfor discriminate provisions in the process. The issue that thisapproach may be institution-based, rather than activity-based


is addressed by a literature review which reveals that MFRC’starget members appear to be NGO MFIs and non-bank finan-cial institutions. It is not clear whether banks are going to bepart of it or the current status of common-bond institutions(stokvels and co-operatives) that already have a similar self-regu-latory/hybrid regime.

The question is whether the South African experience isreplicable in India. The contextual differences in the micro-finance sector of the two countries are:

• The process in India is going be a much more time-consuming exercise if not totally irreplicable;

• India has more varieties of microfinance models;• Regional differences such as the degree of diffusion and

models are perhaps larger in India;• MFIs in India want to mobilize retail deposits to raise

funds and to meet the demand for deposit services;• For South Africa one SRO maybe adequate, but India

is likely to need more than one;• India’s history of unsuccessful government intervention

in rural credit has instilled distrust for government in-volvement in regulation and a strong belief that the poorare not bankable.

5.2.4 Existing law: BancoSol in BoliviaFounded in 1992, Banco Solidario (BancoSol) is the firstprivate commercial bank in the world to do business solelyin the microfinance sector. Its genesis lies in the NGOPRODEM, which established in 1985 was very successfuland as early as 1990 achieved financial self-sustainability, butfinance from donors and self-finance did not suffice its de-mand in lending business. To take deposits, it needed tobecome a formal financial institution. As there was no specialregul-atory framework for MFIs in Bolivia, BancoSol wasfounded as a commercial bank. While BancoSol cleared therequirements such as raising minimum capital and developinga detailed feasibility study that are usually significant hurdles


for NGOs, a number of provisions in the banking law placedan exceptional burden on it:

1. Limit on unsecured loan: The Banks Act stipulates that abank may only grant loans secured by a personal guar-antee to twice the equity capital. In June 1996, 27 percent of BancoSol’s loan portfolio was unsecured, inbreach of this provision. The requirement that loansunder US$ 2,000 need not be secured was not of muchhelp, as group loans were counted as single loans in theeyes of the superintendency and in total, the loan ex-tended to a group usually exceeded the limit.

2. Reporting and disclosure: The requirements were ill-adapted to the needs of an MFI. The business and finan-cial status of each client had to be graded according toprecise conditions resulting in unreasonable costs forshort-term microloans and hampered unbureaucraticgranting of subsequent loans.

3. Security enforcement: The compulsory collection of non-performing loans through legal proceedings was ex-tremely costly for BancoSol. It demanded a more liberalimplementation of the regulations and the option of aloan extension to enable possible repayment.

4. Branch requirements: Opening new branch offices wasonly possible if BancoSol kept customary national open-ing hours and proffered all financial services. The out-come, however, was that many branch offices needed toreach the target groups would have been unprofitable ifthey complied with requirements pertaining to operatinghours and the range of services.

For each of these restrictions, BancoSol proposed alterna-tives that accommodated the special characteristics of microfi-nance while addressing the regulator’s concerns. In 1998, newregulations were enforced that rendered key aspects of micro-lending more flexible.

• Microloans using a specific lending technology and con-sumer loans with maturity of 24 months or under and


below certain amount did not count as non-securedloans whose volume may not exceed double the equitycapital.

• Regulation on loan analysis and records made moreflexible.

• In debt collection, legal proceedings can be taken againstthe whole group of borrowers, implying substantial costsavings.

• Branch offices are permitted to open for only one day aweek and mobile banking services are allowed.

Despite these restrictions and obstacles, BancoSol has

reached breakeven point and achieved considerable success insavings mobilization. BancoSol has achieved a high credit rat-ing enabling it to issue debentures on the US market and hasbroken new ground for other MFIs and the banking sector whowill benefit from the less restrictive regulations of banking law.

5.2.5 Special law: PFFs in BoliviaBy licensing BancoSol, the Bolivian superintendency was ableto gain initial experience with the special features of MFIs. In1995, the Bolivian government enacted a decree introducing anew category of financial institution — Private Financial Funds(PFFs), with the following features:

1. Purpose: PFFs will finance micro and small businesses,individuals’ purchase of durable goods, and may engagein small-scale consumer credit operations.

2. Incorporation: PFFs are organized as corporations. Sucha legal form allows for timely increases or replenishmentof equity and, help attract financial institutions fromabroad, private as well as public.

3. Minimum operating equity: The minimum operatingequity is US$ 1million which is one-third of the amountrequired of a bank.

4. Capital adequacy: The required capital adequacy is 10 percent which is the same level as for banks.


5. Range of financial services: A whole range of financialservices are allowed, including traditional lending, sav-ings and time deposit taking, leasing and factoring. Tolimit the risk, PFFs are not permitted to accept demanddeposits, conduct foreign trade operations, conclude di-rect investments, and manage investment funds.

6. Management: The management must have experience inmicrofinance.

7. Maximum loan amount: The maximum loan amount to asingle client without physical collateral is 1 per cent ofthe equity capital of the PFF and 3 per cent with physicalcollateral.

8. Security: Personal guarantees, movable goods such asprecious stones and other valuables, and group liabilityare accepted as loan security.

9. Provisioning: Yardsticks include the number of days ofoverdue payment and the loan amount.

The first PFF, Caja de Los Andes was established in 1995,

emerging from the NGO Pro-Credito and is successful inlending business. Since 1996, it is engaged in savings business.At the end of 1998 there were five PFFs of which two wereengaged in microfinance. Three NGOs have applied for licenceto the bank superintendency and one NGO is in the processof applying for the license.

PFF is considered as a successful model of a special micro-finance law, but what is often overlooked is that this step wastaken only after several competent NGOs obtained outstandingresults over several years and after the superintendency hadgained experience by supervising BancoSol. The PFF licensewas authorized in a 1993 banking law, but the superintendentand central bank waited until 1995 before approving the decreeimplementing the new license. The PFF license permitted afew strong NGOs to move to the next step of their development— accessing funds from the central bank, institutional inves-tors, and time depositors. The superintendent has not yet al-lowed them to take demand deposits, thereby reflecting its


perception that PFFs do not currently possess the products,systems, or market strategy needed to handle well the smallliquid savings.

The PFF law and its application followed a pattern of grad-ualism in building a financial system for lower-income clients.The special license was developed in response to the emergenceof credibly performing financial NGOs who could afford tooperate with commercial funding. The prospect of a licensemotivated these NGOs to adopt the superintendency’s report-ing standards well before they applied for their new PFF li-censes. The NGOs were sustainable due to prior managementorientation than the chance to be licensed.


6

Self-Regulation in India:Concerns and Prospects

6.1 Why self-regulation in the Indian microfinance sector?

Self-regulation of MFIs is generally viewed as the second bestalternative or as complementary to government regulation inlight of the limited capacity and/or interest of government. Inmost cases, the assumption is that the government after build-ing up sufficient capacity and become familiar with the specificneeds of the microfinance sector will take over regulation ofMFIs. The Task Force Report, contemplates self-regulation asa ultimate form instead of a transitional form of MFI regula-tion. Anticipating a long lead-time to the establishment of aself-regulatory regime, the Task Force recommends that gov-ernment through the RBI temporarily, act as the regulator andsupervisor in the mean time. The practicality of such an ap-proach is debatable because if RBI is capable of regulating andsupervising MFIs, why is self-regulation considered at all?NABARD’s perception that the RBI involvement in the earlystages of self-regulation, would sensitize RBI regarding thespecific characteristics of the microfinance sector has yet notresulted in a strategy of implementation. We fear that by al-lowing RBI to regulate the microfinance sector before acquir-ing enough expertise would have negative consequences withthe self regulatory framework being dictated by the legacy ofa repressive regime or, worse yet, that RBI might refuse to giveup its power.

Given the history of Indian rural credit programmes, it is

clear that the microfinance sector should be left to the marketprinciples and not government. The role of government shouldbe limited to the provision of an enabling environment ratherthan proactively directing or controlling the activities of theplayers. How exactly can government provide an ‘enabling’policy framework? Government intervention tends to be all ornothing and exerting just the right amount of control is noteasy. Hence self-regulation is alternative regulation which ifstructured rightly, can replace government regulation but alsodo a better job because the initiatives are in the hands of MFIs,the norms and rules are set to meet the ground realities andthe needs of the sector thereby preventing repressive regula-tion. Self-regulation can respond to the sector developmentsand innovations more flexibly and quickly because it does notrequire statutory arrangements.

Issues such as: How exactly then can self-regulation beimplemented? Is self-regulation all-powerful? What are thepitfalls that one has to be aware of? are addressed in the sub-sequent sections drawn from literature and interviews withdifferent stakeholders in the sector.

6.2 Objectives and benefits of self-regulationThe objective of self-regulation is to increase the outreach anddepth of microfinance, by improving the performance of cur-rently unregulated MFIs. In India, as in most other countries,the dominant providers of microfinance are formal financialinstitutions and informal MFIs which comprise a negligible sharein the amount of credit disbursed. Nevertheless, it is necessaryto promote informal MFIs, in parallel with formal MFIs, as

• a vast unmet demand for financial services among thepoor still exists;

• it is not realistic to expect conventional formal financialinstitutions to expand their microfinance operations;

• MFIs are more effective in reaching the hardcore poordue to their local knowledge, flexibility and, innovative-ness;


• even in the Bank–SHG programme, the intermediationby MFIs makes it easier for banks to extend credit tothe poor;

• for banks to open branches in very small villages or indeep rural areas may not be economical.

The specific objectives and benefits of self-regulation as

perceived by microfinance players vary based on the differentinterests held by them. Similarly, prioritization of objectivesvary across different stakeholders. The potential objectives andbenefits of self-regulation as listed by our respondents are:

1. Protect depositors: The protection of depositors is the most

important objective of self-regulation (or any form of regu-lation in the financial sector), especially considering thatthe deposits are hard-earned money of the poor. Undercurrent laws, institutions in India are not allowed to takedeposits unless they are licensed either as a bank, an NBFCor, as a co-operative. In practice, however, NGOs, SHGs,and federations of SHGs have mobilized deposits, such asmandatory deposits accompanying credits or voluntary de-posits and have used them as a lending source. Whileacknowledging the need for deposit-taking as an importantcomponent of credit programmes, so far the governmenthas taken a non-interference stance possibly due to thesmall amounts mobilized which did not pose any threat tothe stability of the financial system.

While there is disagreement as to whether ‘earnestmoney’ should be counted as deposits (and thus be officiallyallowed or disallowed) or treated as a collateral (and thusdisregarded), there was consensus that voluntary depositsmust not be handled by unqualified financial intermediar-ies. The majority view appears to be that even mandatorydeposits exceeding a certain threshold value should beregulated (as proposed in the Task Force Report) since themicrofinance sector is yet to be firmly established, a col-lapse of one misbehaving MFI may trigger a run on other

Self-Regulation in India: Concerns and Prospects 53

MFIs. It is unanimously acknowledged that the sector as awhole should build up credibility among depositors.

2. Offer saving services: As a corollary to protecting depositorsmany respondents concurred that deposit-taking is neces-sary not only as a collateral for credit but also as a financialservice. Very often, the constraint faced by the poor is thelack of not credit but saving facilities as they do not haveaccess to saving facilities, and are unable to prepare forcontingency and tend to fall into the poverty trap. Thus,provision of saving facilities is a much needed financialservice and should be provided by professional financialinstitutions that have been accordingly regulated.

3. Gain access to refinance facilities and lower refinancing costs:Although it is generally agreed that the screening of MFIsis the responsibility of the funding agencies and that regu-lators should not be spending resources to support it, onebenefit and a very powerful incentive of self-regulation isthe increased access to refinancing facilities and lower re-financing costs.

The major refinancing sources of MFIs in India accord-ing to BASIX and AIAMED & Opportunity Internationalare: • grants from multilateral and bilateral agencies• grants from the Indian government (via MoF and

other government ministries)• grants and soft loans from apex organizations

(NABARD, SIDBI, NHB, HUDCO, RMK, andHDFC)

Commercial sources of funding that is commercial bankloans, debt instruments, and equity are limited in theamount and in the case of the latter two are not availablefor societies and trusts that comprise the vast majority ofthe MFIs. Expanded access to commercial refinancingsources is necessary for the sector to become financiallysustainable.

Currently, the screening of MFIs is conducted by eachfunding agency using its own appraisal system. It is not


clear if all agencies have the capability to appropriatelyappraise MFIs, which have a very different risk profile fromconventional borrowers. While self-regulation will neverreplace any internal appraisal systems, it can supplementthe screening process, facilitate faster and larger flow offunds to the microfinance sector, and lower the borrowingcosts.

4. Enhance the image of the sector: All the MFIs that wereinterviewed are major players in the Indian microfinancemarket with solid reputation among their clients and fund-ing institutions and, hence face no lack of funding. Theirprimary motivation for regulation was therefore to expelloan sharks and ill-intentioned organizations from themarket. It was agreed that, given the mushrooming ofNGOs and the NBFC fiasco in recent years, there shouldbe a mechanism to sift good MFIs from bad MFIs and thatsuch a distinction should be understood by the public andfunding agencies.

5. Help MFIs build capacity and improve performance: Capacitybuilding is particularly relevant to NGO MFIs that lacksa management and governance structure to survive as aprofessional and financially sustainable financial institu-tion. This may not be a serious problem for those NGOMFIs who do not plan to expand their business (not all ofthe MFIs that were met were pursuing expansion) but, isan issue to be considered if the sector has to grow anddeepen. Being part of a self-regulatory regime will forceMFIs to act like a proper financial institution.

6. Pre-empt repressive government intervention: Many of themicro-finance practitioners that were interviewed felt thatit was a matter of time before the government jumped into regulate the microfinance sector, just as it did followingthe collapse of some NBFCs. Government regulation fol-lowing a financial disaster would naturally be repressiverather than enabling. Self-regulation is a way to ensure thatregulation serves its purpose of promoting rather thanstifling the sector. Involving government in the process of


establishing self-regulatory framework will not only pre-empt repressive government intervention but also help todefine an enabling policy environment for the future.

6.3 Who should come under self-regulation?The academic trend perceives microfinance as a line of businessand that regulation thereof (be it government regulation orself- regulation) should be activity-based, rather than institu-tion-based. Activity-based regulation offers a level playing fieldfor all those engaged in the same business of microfinance andprevents proliferation of similar regulations. Accordingly allinstitutions, acting as micro-financial intermediaries shouldcome under the self-regulatory regime. In India, they rangefrom SHGs to the microfinance windows of commercial banksand from the practical perspective the following are suggested: SHGs: SHGs are too small and too numerous to be regulated.Moreover, their strong internal regulation mechanism elimin-ates the need for any external regulation.

Federations of SHGs: Federations that are just clusters of SHGsdo not need to be regulated but are acting as fund manager ofSHGs (smoothing funding deficit or surplus of one SHG toanother) should come under self-regulation.

NGO MFIs: NGO MFIs are the primary target of self-regulation.

NGO facilitators: NGOs acting as facilitators only should beregulated but in a different regime and not in the MFI self-regulation, unless they are engaged in financial intermediaryactivities despite their claim to be a pure facilitator.

Co-operatives: Co-operatives take the position that as member-based organizations, they are subject to strong internal regula-tion and therefore do not need any external regulation otherthan RBI’s regulation. A contending argument offered is that itis unrealistic to assume that an average co-operative memberwould know what the co-operative is doing with his/her money


and that ‘progressive’ MACS Act co-operatives, that are sup-posed to be truly member-controlled, are still rare. We believethat those co-operatives who aim to become a serious microfi-nance player should come under the self-regulatory regime.

Other formal MFIs (banks, NBFCs and LABs): Already regulatedand supervised by RBI, subjecting them to another set of regu-lation (although going to be less stringent than RBI regulation)may on the one hand give them additional burden and detertheir appetite for microfinance business, but on the other hand,enhance the credibility of the self-regulatory regime and thestandards practised therein. At least NBFCs and LABs special-ized in microfinance should join the self-regulatory regime.

6.4 What should SROs do?The task expected of SROs ranged as follows:

a) simply check if MFIs are really serving the poor (forexample at least 80 per cent of the portfolio is for thepoor), rather than impose prudential norms or any per-formance standards;

b) set accountancy rules, reporting and, disclosure require-ments; establish prudential norms (reserve requirements,capital adequacy, minimum capital amount, provisioningrequirements, etc.) and performance standards (financialperformance, management quality, sustainability, etc.)and, accredit the complying MFIs;

c) give credit ratings; andd) provide a deposit insurance financed from contributions

of members.

The predominant view of the SRO roles was (b). An argu-ment against (c) was that regulator/supervisor is fundamentallydifferent from a rating agency, whose role is to support inves-tors’ judgement on the investee’s ability to repay its debt. Asan industry body (even if independent), SROs would not beable to tell whether one MFI is better than another, while (d),was certainly desirable but appeared to be futuristic.


Most of the respondents agreed that SROs must be anindependent watchdog and thus should not perform the fol-lowing functions:

• representing MFIs on various forum and lobbying whichshould be done by industry bodies;

• training and technical assistance of MFIs should be doneby industry bodies;

• internal regulation of MFIs should be done throughgovernance and with assistance if necessary by industrybodies.

6.5 Who should be SROs?Generally, regulation (norms and standards) could be estab-lished by MFIs themselves (or their associations), but super-vision must be done by an independent institution. MFIs(associations) would face an obvious conflict of interest intrying to promote their business as well as functioning as theirown watchdog. Neither should apex organizations alone actas SROs as they may want to increase the number of MFIsto wield greater influence and, are unlikely to close down MFIsthat owed them money. A not-for-profit institution set upwith a well-balanced representation of MFIs, apex organiza-tions and, commercial banks (for their expertise) would con-stitute the ideal SRO.

It is probably not feasible to have a fully capable and inde-pendent SRO from the beginning but then the demand formicrofinance SROs is not equally strong across the country. Inregions where microfinance outreach is still small, the imminentneed is increasing the number and outreach of MFIs rather thanregulating their activities. In a monopoly situation self-regula-tion, if introduced, will not be enforced. What may be a morerealistic approach is to start off with MFI associations acting asSROs on an experimental basis in a few selected states wherecritical mass of MFIs exist. As the MFI track record and publicconfidence in them build up, they should convert to inde-pendent SROs and other states can replicate the experience.


Self-regulation has rarely worked in developing countriesdue to a conflict of interest inherent in the system (Christenand Rosenberg 1999). The key to effective self-regulation isenforceability, that is to provide incentives of compliance andsanctions for non-compliance, for example, certain privilegessuch as access to refinance and liquidity pool or deposit-takingshould be made conditional upon accreditation or rating bySROs. Government should also confer the exclusive right onSROs to close down MFIs performing badly.

How far should RBI be involved in the self-regulatoryregime? While giving the necessary ‘teeth’ to the regime itwould be against the spirit of self-regulation and might leadto excessive intervention. The international experience is tooyoung to give any conclusive evidence on neither of thesearguments.

Respondents were unanimous that SROs should be recog-nized by RBI by way of statutory arrangement either by amend-ing the RBI Act or by enacting a separate act. RBI should bekept well-informed during the process of establishing the self-regulatory regime.

6.6 Typology of SROsThe Task Force Report proposes one SRO to cover minimumfifty MFIs and assumes multiple SROs. The advantages ofmultiple SROs are: relative ease of implementation especiallywhere it is impractical to bring all MFIs into one umbrelladue to their differences in the methodology, geographicalcoverage, target clients, etc.; competition among SROs willmaintain high standards; and prevent one SRO from becomingtoo powerful. The disadvantages are: variance in performancestandards under different SROs; potential confusion amongthe public and funding institutions as to what each SROrepresents; excessive competition among SROs lowering over-all standards; and with limited human and financial resources,it is better to create one good SRO than a number of not-so-good SROs.


Though international literature recommends a single coun-try-wide SRO, the respondents were unanimous that this is notan option in the Indian context, where the microfinance modelsare too diverse and too scattered to be bundled under oneregulatory regime. Instead multiple SROs should exist differen-tiated by (i) region, (ii) type of institution, (iii) maturity, orpotentially a combination of these.

i) SROs by region: Establish regional SROs, each covering onelarge state (where there are many MFIs) or a few smaller states(where there are not so many MFIs), and integrate them by thenational level SRO. (Fig. 6.1)

Fig. 6.1: SROs by Region

The advantage is that this is probably the easiest to admin-istratively implement due to the physical proximity and regionalhomogeneity among MFIs, especially given that societies andtrust that comprise the majority of MFIs are governed by stateregulations. However, the drawback is the diversity in the modeland philosophy of MFIs may outweigh the regional homoge-neity and hinder effective coordination.

ii) SROs by type of institution: Establish an SRO for each type ofinstitution for example, an SRO for co-operatives, an SRO forNBFC MFIs, an SRO for NGO-MFIs, etc. (Fig. 6.2)

The advantage is that by bundling by a type of institutionis the most typical way of self-regulation with least resistancefrom MFIs. While the drawback is that being an institution-based approach it may end up in proliferation of SROs for thesame line of business.

National SRO

Regional SRO Regional SRO Regional SRO


Fig. 6.2: SROs by Institution Type

Fig. 6.3: SROs by Maturity

iii) SROs by maturity: Establish an SRO with mature MFIs only,excluding nascent MFIs. (Fig. 6.3)

The advantages being that as only mature MFIs are themembers, the SRO can exercise higher standards than an SROwith MFIs of all development stages. The SRO can quicklybecome a brand. The drawback lies in the risk of polarizationbetween good MFIs and bad MFIs. An elite club like this willgenerate the culture of exclusion rather than inclusion, and maydiscourage nascent MFIs which are precisely the target ofself-regulation from joining the regime.

Whichever typology is adopted, the key to a successfulself-regulatory regime is to put homogenous MFIs together.Other issues to be considered are:

• each SRO should cover only a manageable number ofMFIs. Setting regulation is relatively easy; the difficultpart is the enforcement. If regulation cannot be en-forced, there should rather be no regulation as it is

Coop SRO

NGO MFI SRO SHG Federation

NBFC SRO

Mature MFIs

Nascent MFIs


dangerous if regulation is taken to be something to beignored. SROs must ensure the implementation of thestandards they set;

• SROs themselves should be subject to certain standardsto ensure good performance. This however, will raiseissues such as who is going to monitor SROs, howpublicity would be given to SROs doing better thanother SROs; and

• should SROs be competing? Would competition raiseor lower the standards exercised? Should MFIs have theoption to choose the SRO that suits them best? Howwould we ensure that SRO migration (an MFI disquali-fied by certain SRO getting accredited by another) doesnot occur?

6.7 How feasible is self-regulation?Literature suggests that the feasibility of self-regulation is ingeneral a function of: the extent to which there is an apex bodythat can represent MFIs as a whole, the quantum of resourcesavailable for monitoring and supervision and, the availabilityof incentives and/or sanctions to enforce compliance.

India, is likely to face constraints in all of these dimensionsbecause of the large number and diversity of MFIs. The specificconcerns and doubts pertaining to the nature of the self-regu-latory regime as articulated by the respondents, are summarizedbelow:

NGOs/MFIs: The SRO may lack neutrality especially if itevolves out of a MFI association, would not the SRO controlour business?; regulation already exists covering all institu-tions. what is the need for an SRO?; maybe an SRO is nec-essary but it will obscure the fact that what is really neededis a modification and updating of the outdated laws withoutwhich the SRO won’t be too effective; whose interests willthe SRO be serving?; there is a chance that the SRO will be‘elitist’; the SRO must have a community orientation; the SRO


should have a larger perspective about how to mainstreamMFIs and cannot act like a grassroots organization; the SROmust impose requirements of systems at an ‘appropriate’ levelgiven the nature of the microfinance programme that a par-ticular entity is conducting; there are preconditions to estab-lishing an SRO — professional appreciation, scale of operation,minimum level of standards in systems and, a self-regulatoryframework in the context of microfinance has to take intoaccount social measurements as well as financial performance.

Donors (multilateral and bilateral): Would it address the currentproblems being faced by government programmes?; monopo-listic power of SRO if only one is recognized; the incen-tives/disincentives of belonging are not clear; there isreluctance on the part of the government to devolve regulatoryauthority; if the membership in the SRO is not mandatory, itwould not work; the government cannot get too deeply in-volved in this as it might damage the whole process; need forconsistency in the enforcement of standards and confidential-ity; the SRO has to be very precise about what regulation wouldconsist and, there have to be standards for the SROs as well.

Apex and government funding organizations: Large NGOs are notamenable to self-regulation because they are too strongly man-aged, their stake is too high and credit ratings can do the job;an SRO needs discipline and must have systems built up tocheck utilization and portfolio tracking; the SRO needs to havean appropriate stakeholder profile and not be dominated solelyby the practitioners; and starting big is unrealistic.

Government: RBI cannot delegate regulatory authority except byan Act of Parliament. Therefore, SRO could never have ‘teeth’;since RBI has deregulated the microfinance sector, it cannotimpose conditions of belonging to an SRO to an MFI; is thereany organization with the competence to monitor these MFIs?;if the SRO seeks to be recognized by RBI, it will take anotherfive years because an act of parliament is required; self-regulationis a necessary but not sufficient condition. External regulation


is also necessary; and possible entry of misbehavers is a risk thathas to be taken for success — so do not regulate just yet and letthe sector innovate.

Consultancies: Rating agency approach is inappropriate forSRO; in certain states, microfinance has not reached criticalmass to think about regulation; any grading system wouldexclude well-intentioned NGOs with insufficient capacity;malpractice in NGOs may not be due to regulation; and wehave to find the true cause first; ratings and code of conductare biased towards larger players and do not measure capacityor good intentions of smaller players; and the SRO cannot beintimidating for the MFIs and it must help them along intheir standards process.

In conclusion, NGOs expressed greatest concerns and doubts,particularly on the potential hazards of self-regulation which isunderstandable given that they have so far been successfullyoperating under the least regulated environment and thereforewould be affected most by the introduction of self-regulation(see Table 6.1). In contrast, for-profit MFIs were not worriedat all and appeared to think that self-regulation is a genuinelygood idea. The apex organizations also appeared optimistic andtheir concerns were on more technical matters such as neutralityand capacity of the SRO. Within the government, the RBI wasquestioning the justification for having self-regulation in addi-tion to the existing regulation, whereas NABARD and SIDBIwere highly positive though not totally sure how to implementit. Some of the concerns articulated are:

The SRO will not be a neutral watchdog. The SRO will bebiased towards large players and exclude small ones. The SROwill not have a social orientation. SRO adds no value to existingregulation. SRO does not provide enough incentives for MFIsto join. SRO will not have the necessary ‘teeth’ — no statutoryauthority to regulate. SRO will not have enough capacity toregulate the MFIs. Microfinance sector has not reached a crit-ical mass for regulation.


Table 6.1: Concerns and doubts on self-regulation

Concerns

Who Lack

of n

eutr

ality

Bias

tow

ards

larg

e M

FIs

Litt

le so

cial o

rien

tatio

n

No

adde

d va

lue

No

‘teet

h’

No

ince

ntiv

es to

join

Inad

equa

te ca

pacit

y

Lack

of c

ritic

al m

ass

NGOs • • • • • • •For-profitMFIsDonors • • •Government • • • •Apex • •Consultancies • •

6.8 DissemnationWorkshop: Issues and ConcernsIn the disemination workhop there was a consensus that MFIs,excluding SHGs, should participate in a self-regulatory regime.It was unanimously suggested that refinancing agencies such asapex organizations, other lenders, and donors become subjectto a self-regulatory mechanism presumably separately from thatfor MFIs. MFIs can get refinancing agencies to use the SROaccreditation as one of the criteria for their appraisal of MFIs.Given that the government credit schemes constitute the domi-nant share of the microfinance activities in India it was sug-gested that the government credit schemes should be (self)regulated or ‘better monitored’. The shared view was that thegovernment is concerned only with the volume of credit exec-uted without giving regard to the quality, such as the repaymentrate, the identity of the borrowers (are they the hardcore


poor?), and the effectiveness of credit. Assuming that there willbe multiple SROs, the SROs themselves should be self-regu-lated. The performance of the government regulatory authori-ties is monitored by the public and could be improved bychanging governments, but who is going to watch the perform-ance of SROs?

Consensus was expressed that the activity-based approachwould be superior to the institution-based approach because ofits simplicity and the ability to compare MFIs of differentinstitutional types by the same measure. All MFIs with depositand loan portfolio volumes exceeding certain thresholds shouldcomply with certain minimum prudential norms and perform-ance standards. The advantages and disadvantages of the twoapproaches are summarized in Table 6.2.

Table 6.2: Activity/Institution approach based Regulation

Approach Advantages Disadvantages

Activity-based • Similar activities can be regulated by one regulation

• Comparison of MFIs will be easier

• Simple framework• Common perfor-

mance indicators can be used

• Likely to invite resistance

• The process of establishing the regime will be complicated and take time

Institution-based • Administratively easier

• Lack of uniform-ity in regulation for similar activ-ities

A view was expressed that while SROs should be activity-based, there should also be divisions along regional and/or statelines.

It is important that the whole process of establishing a self-regulatory regime be done in a bottom-up manner, involving


all players — MFIs, the government, and apex agencies. To giveteeth and authenticity to the regime, the SROs should be statu-torily recognized by RBI and be established with representativesof the government, RBI and apex agencies but should not bedictated by them. It is important that their involvement besought only to the extent that sufficient regulatory know-howis passed on to the SROs and that they accept and take intoaccount the SRO accreditation in their appraisal of MFIs. Giventhat the primary objective of regulation is to protect the deposi-tors, a deposit insurance mechanism should be created in addi-tion to the prohibition on the use of deposit for speculativepurposes. A minimum level of regulation can be accomplishedby registration.

Needless to say, it is imperative that MFIs themselves berepresented in the SROs to ensure that the regulatory regimeis not repressive and meets the ground realities of the microf-inance activities. To eliminate bias towards any particularMFIs, they should be represented on a rotational basis. Toensure a fair and effective enforcement of the rules and norms,the use of arbitration mechanism may be considered.


7

Self-Regulation: Potential and Pre-conditions

The main findings of this study are summarized in thischapter.

7.1 Potential of Microfinance Regulation in IndiaThe objectives of microfinance regulation are two-fold:

1. To develop a market-based financial system that ensuressufficient competition and incentives to provide the low-est-cost services possible to the poor. This is a pre-con-dition for ‘mainstreaming’ the rural poor as clients offinancial services.

2. To raise the standard of practice, make it sustainable,and enable it to contribute to the development of thefinancial system.

The establishment of a microfinance regulatory regimeshould be undertaken taking into account the specifics of theIndian context, such as:

• The lack of any market-based incentives for the per-formance of the channels and systematic erosion of thecredit discipline of banks as well as borrowers due thecontinued use of inappropriate lending technology. Theunderlying problem of the confusion of policy and regu-lation has resulted in the hardcore poor to contnue tobe excluded from the financial system and there is a vastunmet demand for microfinance services.

• The recent mushrooming of informal MFIs should bewelcomed. However, it also means an increasing risk ofmalpractice which may cause a system-wide instability.Malpractice in an infant industry may be highly detri-mental to its orderly growth and malpractice by financialinstitutions is particularly dangerous and must beavoided at all costs. Regulation is necessary to eliminateviolators, to improve the operation of well-intentionedbut unprofessional MFIs, and ultimately to increase theoutreach and broaden the service of MFIs.

We believe that self-regulation is feasible and the mostsuitable way of microfinance regulation in India given that:

• In the light of the history of Indian rural finance, self-regulation is considered better than government regu-lation. Even if the government is to ultimately take overregulation, it is better to start off with self-regulation topre-empt repressive regulation. Self-regulation wouldallow flexibility and speed needed for a rapidly develop-ing sector.

• There are precedents of self-regulation in the Philip-pines and South Africa, which India may be able toreplicate. Formation of Sa-Dhan is already the first stepin this direction.

• Our field interviews with microfinance practitioners,regulators, apex organizations, and donor agencies sug-gest that there is a broad unanimity on the necessity ofa self-regulatory regime. However, it was pointed outthat not all regions in India have reached the criticalmass for MFI regulation.

• The feasibility of self-regulation is a function of —(i) the extent to which there is an apex body that canrepresent MFIs as a whole — while activity-based ap-proach is the trend in financial sector regulation world-wide, it may not be easy in India because the IndianMFIs vary enormously in the methodology, businessmodel, philosophy, and institutional form. The most

Self-Regulation: Potential and Pre-conditions 69

feasible way would be to make use of the existing MFIassociations’ membership. This has the potential ofexcluding smaller MFIs that are actually the primarytarget for the self-regulatory regime, but is the quickestway to implementation; (ii) the quantum of resourcesavailable for supervision — human resources of RBI,NABARD, SIDBI, commercial banks, consultants, andpossibly microfinance regulators in other countriesshould be tapped. Requiring MFIs to use managementinformation systems would save the on-site inspectionprocess significantly. The cost of supervision should beborne by MFIs, except government support (from e.g.the Microfinance Development Fund) could be consid-ered for small MFIs in the initial years; (iii) the avail-ability of incentives and sanctions to enforce compliance— the enforcement power could be enhanced by (a)making the SROs a strong brand name, (b) recognitionof the SROs by RBI, and (c) recognition of the SROaccreditation by donors and lenders.

• Considering the constraints in resources and regionaldifferences in the stage of development of microfinanceactivities, it is not practical to attempt to start self-regu-lation on a national basis. Self-regulation should beintroduced in selected parts of India, with selected MFIs,on an incremental basis, addressing the potential issuesstep by step.

The challenges for India, however, are (i) the diversity of

the microfinance models, (ii) the size of the country, (iii) theregional diversity (in many regions, MFIs are monopoly and/orthe critical mass for regulation has not been reached). Thesemake it difficult to implement any one regulatory regime.

Views on the specifications of the self-regulatory regimevary, such as the specific mechanism of the regime, the identityof the SROs, and the typology of SROs. In addition, concernswere expressed on various aspects of the potential self-regu-latory regime such as its neutrality, potential bias against small


players, ability to maintain a social orientation, and enforce-ment power.

7.2 Pre-conditions to self-regulationAssuming that consensus can be achieved for the creation of aself-regulatory regime, certain pre-conditions such as externaland internal need to be satisfied before any self-regulatoryregime can function as intended.

External pre-conditions:• To establish meaningful performance standards, the array

of microfinance models should ideally converge to a smallervariety. As currently practised, microfinance methodolo-gies may be too varied to be subject to any uniform stand-ards. Convergence can be facilitated by collection anddissemination of best practices without sacrificing innova-tiveness or effectiveness. Different modes may representthe ability to serve customers with different needs or underdifferent conditions. Different ways to effectively cover alltypes of MFIs (not necessarily under the same umbrella)without proliferation of regulations need to be evolved.

• Consensus should exist among microfinance practitionersand authorities that self-regulation will serve the micro-fi-nance sector better than government regulation. NGOs bydefinition are an antithesis to government intervention andthus are likely to support self-regulation over governmentregulation if they have to choose one but it is questionablewhether they will choose to be regulated at all.

• There are few incentives for either large/mature MFIs orsmall/nascent MFIs to subject themselves to (additional)regulation. Large/mature MFIs are doing well without anyofficial stamp of approval (their track record acts as a stampof approval). However, the potential impact on societyshould they go bust is significant, and therefore they shouldbe made part of the self-regulatory regime. Small/nascentMFIs could be incentivized to join the self-regulatory re-

Self-Regulation: Potential and Pre-conditions 71

gime only if they face competition in getting clients orfunding. In many rural areas, MFIs are monopolies. Thus,the incentives could be provided only from the fundingside, that is donors/lenders should make their grants/loansconditional on SRO accreditation. Funding agenciesshould become more responsible for their actions and re-sponsive to the needs of microfinance sector. They shouldnot pour in money to MFIs that are not professional finan-cial institutions.

Internal pre-conditions:• Many NGOs are likely to face an identity crisis when

joining a self-regulatory regime because they will be forcedto act as a proper financial institution. The common notionthat social orientation and financial sustainability are in-compatible should be examined. The formalization wouldenable NGOs to increase their outreach and offer betterand broader services. As a formal financial institution, anMFI can attract more funds from broader funding basesand at lower costs.

• NGOs should build the necessary skill sets to becomeproper financial institutions as well as the capacity forgreater reach and sustainability. It consists of effective gov-ernance structures (a well-functioning board of directors)and various management control systems, including writtenpolicies and procedures, internal controls, loan review,compliance, planning, budgeting, internal and externalauditing, and management information systems.


References

AIAMED and Opportunity International (1999), A Will Needing aWay: Exploring the Legal and Procedural Constraints in Micro-Fi-nance, New Delhi: AIAMED and Opportunity International.

Arunachalam, Ramesh (1999), Alternative Technologies in the IndianMicro-Finance Industry, New Delhi: Action Aid.

Berenbach, Shari and Churchill, Craig (1997), Regulation and Super-vision of Microfinance Institutions: Experience from Latin America,Asia and Africa, Washington, D.C.: The Microfinance NetworkOccasional Paper No. 1.

Blundell, J. and Robinson, C. (1999), Regulation Without the State,The Institute of Economic Affairs, Occasional Paper 109.

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Annexure 1

Stakeholders:

Government agencies RBI (RPCD, DNBS and NewDelhi Office), NABARD, BIRD,SIDBI Foundation, UPLDC, RMK

Apex and government funding agencies

FWWB, HDFC, HUDCO

For profit MFIs Mu-tual Benefit

SEWA Bank, BASIX, SHAREMicrofin Ltd

NGO MFIs Annapurna, ASA, LEAD, SJSK,CCD, ASSEFA

Co-operatives CDF

Facilitator NGOs DHAN Foundation, IDPMS,MYRADA, NESA, New PublicSchool Samiti, Outreach,PRADAN, Sarvodaya Ashram,CARE, DATA

Consultants, SupportOrganizations

ARAVALI, EDA Rural Systems,Sudrak, Manavodaya, MicrofinanceConsulting Group, PriceWaterhouse Coopers, AIAMED

Donor agencies DFID, GTZ, SDC, USAID, FORD

Commercial banks Bank of India, Canara Bank

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Annexure 2

Micro Credit

RPCD.NO.PL.BC. 62 /04.09.01/99–2000 February 18, 2000

ToAll Scheduled Commercial Banks (including Regional Rural Banks)

Dear Sir

MICRO CREDIT

A Micro Credit Special Cell was set up in RBI to suggest measuresfor augmenting flow of micro credit. Please refer in this connectionto paragraph 64 of our circular No. BC.185/07.01.279/98–99 datedApril 20, 1999 and paragraph 51 of our circular No. BC.190/07.01.279/98–99 dated October 29, 1999. This Cell has since sub-mitted its report. In the meantime, a Task Force on Supportive Policyand Regulatory Framework for Micro Credit was set up by NABARDand its report has also been presented. Micro credit is defined as theprovision of thrift, credit and other financial services and products ofvery small amount to the poor in rural, semi-urban and urban areasfor enabling them to raise their income levels and improve livingstandards. Micro Credit institutions are those which provide thesefacilities.

2. In this context, it has been decided that banks may follow theundernoted guidelines for mainstreaming micro credit and enhancingthe outreach of micro credit providers:

(i) As mentioned in our circular RPCD.No.PL.BC. 94/04.09.01/98–99 dated April 24, 1999, interest rates applicable to loans given bybanks to micro credit organisations or by the micro credit organisa-tions to Self-Help Groups/member beneficiaries has been left to theirdiscretion. The interest rate ceiling applicable to direct small loansgiven by banks to individual borrowers, however, continues to remainin force.(ii) The banks may formulate their own model(s) or choose anyconduit/intermediary for extending micro credit. They may choose

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suitable branches/pockets/areas where micro credit programmes canbe implemented. It will be useful in our view to start with a selectedsmall area and concentrate fully on the poor in that area and thereafterwith the experience gained replicate the arrangement in other selectedareas. Micro Credit extended by banks to individual borrowers dir-ectly or through any intermediary would be reckoned as part of theirpriority sector lending.(iii) The criteria for selection of micro credit organisations are notbeing prescribed. It may, however, be desirable for banks to deal withmicro credit organisations having proper credentials, track record,system of maintaining accounts and records with regular audits inplace and manpower for closer supervision and follow-up.(iv) Banks may prescribe their own lending norms keeping in viewthe ground realities. They may devise appropriate loan and savingsproducts and the related terms and conditions including the size ofthe loan, unit cost, unit size, maturity period, grace period, margins,etc. The intention is to provide maximum flexibility in regard to microlending keeping in view the prevalent local conditions and the needfor provision of finance to the poor. Such credit should, therefore,cover not only consumption and production loans for various farmand non-farm activities of the poor but also include their other creditneeds such as housing and shelter improvements.(v) Micro credit should henceforth be included in branch credit plan,block credit plan, district credit plan and state credit plan of eachbank. While no target is being prescribed for micro credit, utmostpriority should be accorded to the micro credit sector in preparationof these plans. As advised in our circular RPCD.PL.BC.28/04.09.22/99-2000 dated September 30, 1999, micro credit should also form anintegral part of the bank’s corporate credit plan and should be re-viewed at the highest level on a quarterly basis.(vi) A simple system requiring minimum procedures and documen-tation is a pre-condition for augmenting flow of micro credit. Hencebanks should strive to remove all operational irritants and makearrangements to expeditiously sanction and disburse micro credit bydelegating adequate sanctioning powers to branch managers. Theloan application forms, procedures and documents should be madesimple. It would help in providing prompt and hassle-free microcredit.(vii) A statement should be furnished to RPCD, RBI on a half-yearlybasis indicating the amount of micro credit disbursed by the bank. In

Annexures 77

this connection, we have revised the format for the Progress Reporton the Financing of Self-Help Groups by banks presently beingsubmitted by you to both NABARD and us as prescribed vide ourcircular RPCD.PL.969/04.09.22/97-98 dated May 05, 1998. A copyof the revised statement format is enclosed. The first such statementshould relate to the period ending March 2000.

Banks should initiate immediate action in regard to the above underadvice to us.

3. Please acknowledge receipt of this letter.

Yours faithfully(B.R. Verma)Chief General Manager-in-Charge Encls.: 3


Annexure 3

Amendments to NBFC Regulations

Ref.DNBS.(PD).CC. No. 12/02.01/99–2000 January 13, 2000 To All Non-Banking Financial Companiesincluding Residuary Non-Banking Companies

Dear Sirs,

Amendments to NBFC Regulations

As you are aware, Reserve Bank has put in place a comprehensiveregulatory and supervisory framework in January 1998, in terms ofwhich certain measures were taken for protecting the interests ofdepositors and for ensuring that the NBFCs function on sound andhealthy lines. Reserve Bank has since received a number of suggestionsfor fine tuning the regulations with a view to enhancing the protectionto the interests of the depositors and ensuring that the NBFCs con-tinue to play their legitimate role in the Indian Financial System.Accordingly, the following changes are being effected in the regula-tions:

A. Statutory changes

(1) NBFCs engaged in micro-financing activities

In the backdrop of the need for a suitable national policy frameworkfor implementation of many credit linked poverty alleviation pro-grammes to meet the needs of hard core and asset-less poor, a HighPowered Working Group on Micro Financing in India was consti-tuted by NABARD to recommend a policy framework for sustainablegrowth of micro finance in the country with participation of commu-nity based organisations at the grass root level. The Task Forcesubmitted its Report on October 18, 1999. The Working Group has, inter alia, recommended that the policyand regulatory framework should give a fillip to the Self Help Groups(SHGs) or Non-Governmental Organisations (NGOs) engaged inmicro-financing activities. Accordingly, it has been decided to exemptsuch NBFCs which are engaged in (i) micro financing activities,

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(ii) licensed under Section 25 of the Companies Act, 1956 and(iii) which are not accepting public deposits from the purview ofSections 45-IA (registration), 45-IB (maintenance of liquid assets) and45-IC (transfer of profits to Reserve Fund) of RBI Act, 1934.


Documents

Microfinance Regulation in India [email protected] Sa-Dhan vii Acknowledgement D iscussions for the research outline for this report began immediately after the presentation