Paper on. Regulation and Supervision of Microfinance Institutions: Principles and Best Practices

Transcription

1 Paper on Regulation and Supervision of Microfinance Institutions: Principles and Best Practices Dr. Tuli Roy RESERVE BANK OF INDIA SAARCFINANCE Seminar on Regulation and Supervision of Microfinance Institutions in SAARC Region March 20-22, 2013, Kathmandu Nepal 1

2 Regulation and Supervision of Microfinance Institutions: Principles and Best Practices Introduction: As per the Sa-Dhan Bharat Microfinance Report of 2011, MFIs operate in 517 districts of India spread across 27 states. The total MFI -client outreach as of March 2011 was 31.7 million while the total microcredit outstanding was Rs billion. In addition, MFIs manage estimated loan portfolio of Rs billion which have been securitized to banks. MFIs collectively disbursed Rs billion as loans to clients during The average loan per client stood at Rs which is less than that of last year figure of Rs In , more than one-third of MFIs displayed negative growth in client and loan portfolio. This was due to the problem in the state of Andhra Pradesh. Background: In May 2010 the State Government conveyed to the Reserve Bank of India the concerns regarding the MFIs which were as follows: i) Charging of usurious interest rates; ii) Resorting to coercive recovery practices; and iii) Malpractices in lending such as multiple lending, ever greening of loans, lending beyond the debt sustainability of households, etc. The above concerns were amplified by the perception that the MFI sector is disproportionately benefitting the private shareholders, including foreign investors at the expense of poor borrowers. The huge valuations attracted by Ms SKS Microfinance in their IPO reaffirmed these perceptions. The State Government imposed the AP Ordinance which had very restrictive clauses. In the wake of the AP ordinance and given its wider ramifications there was an urgent need for an improved understanding of the sector to determine the future 2

3 course of action. Accordingly, a Sub-Committee chaired by Shri Y H Malegam, a senior member of the Reserve Bank s Central Board of Directors was set up. The Committee examined the prevalent practices of MFIs in regard to interest rates, lending and recovery practices to identify trends that impinge on borrowers interests and examined the conditions under which loans to MFIs can be classified as priority sector lending and made appropriate recommendations. The paper is structured along the following lines: A. Principles of prudential regulation B. Supervisory methods: on-site and off-site C. Regulatory requirements for market discipline and public disclosure D. Licensing policy of MFIs for inclusive financial growth E. Basel Core Principles for Effective Banking Supervision F. Corporate governance in MFIs G. Best regulatory and supervisory practices Principles of prudential regulation: Till 2011 there was no separate category called the Microfinance Companies. All companies which carried out microfinance activities were treated as loan companies and were regulated as a loan NBFC. All NBFCs are subject to similar prudential norms as banks except in a few areas such as income recognition. They have more relaxed delinquency norms of 6 months to 12 months as compared to 90 days norms in case of banks. However, the capital adequacy for NBFCs is much higher than banks which are subject to requirement of minimum CRAR of 9% as compared to 15% in case of NBFCs. Non Deposit taking NBFCs with assets of Rs 1 billion are not subject to CRAR requirements and prudential limits on credit concentration. However, non deposit taking NBFCs do not have any restrictions on investments in land and buildings and unquoted shares. There are restrictions on single and group borrower limit. There 3

4 are no restrictions on the extent to which small NBFCs ND (those with assets below Rs 1 billion) may leverage, even though they are in the financial services sector. Supervisory methods: on-site and off-site Presently supervision and regulation of NBFCs are based on the four pillars of onsite supervision, off-site monitoring, market intelligence and exception reports received from auditors. The approach continues to be micro-prudential and focussed on individual institutions. The on-site inspection of NBFCs is on CAMELS pattern and is conducted at annual intervals and also depending upon the supervisory concern. The inspection findings are communicated to the concerned NBFC through a supervisory letter, advising the company to submit its compliance / plan of action for rectification of deficiencies. Depending upon the nature and seriousness of supervisory concern, as observed during the course of inspection, other supervisory actions are initiated as deemed appropriate. It may be pertinent to mention that failures / aberrations in respect of such large NBFCs can also cause significant damage to the system even if they are not accepting public deposits. The Bank has a system of off-site surveillance, which encompasses submission of the supervisory returns by the NBFCs for effective monitoring their activities in an ongoing manner. The off-site surveillance system is supported by a state-of-the art technology for the development of database as well as for effective scrutiny and monitoring of the returns. The project enables the NBFCs to submit their returns through internet. Presently non deposit taking NBFCs with asset size Rs billion and above but less than Rs. 1 billion have to submit a quarterly return on important financial parameters including their capital market exposure. NBFCs-ND-SI( ie those with assets of Rs 1 billion and above) have to submit monthly return on important financial parameters as well as ALM returns. (Other NBFCs-ND are not required to submit any returns to RBI). Auditors are seen as a very important part of the supervisory process, supplementing the efforts of the Bank inspecting officers. The RBI Act also gives the 4

5 Bank power to issue directions to auditors relating to the balance sheet etc. It further empowers the Bank to appoint an auditor to conduct a special audit of the accounts of the NBFC relating to any transaction/s in the public interest. Market intelligence is gathered from newspaper reports, complaints, advertisements, news about the functioning of other NBFCs gathered during inspection, information sharing between different departments of the Bank and between different financial regulators etc. Regulatory requirements for market discipline and public disclosure Presently, balance sheet disclosures by NBFCs are largely guided by those laid down by the Companies Act 1956 and SEBI disclosure regulations, if listed. In addition Reserve Bank has mandated that every NBFC shall append to its balance sheet the following particulars: Details of loans and advances availed by the NBFC, public deposits, bills receivable, lease and hire purchase assets, investments, borrower group-wise classification, investor group wise classification and details of its non-performing assets. However with market discipline being recognized as a key driver for business conduct the need for increased transparency is gaining ground. The issue is being revisited to improve upon the existing disclosure practices by the companies. Most NBFCs have linkages to the financial system through bank credit which they on-lend. Many of them have also accessed funds from the market in the form of Inter-corporate deposits or through the capital markets. Several of them have attained a critical mass of business and are treated as systemically important NBFCs. It is therefore desirable that all the stakeholders of NBFCs have the necessary information on the financial health of the company to make informed decisions. The disclosure principle calls for financial reporting of significant facts that are likely to affect the judgment of an informed reader. Licensing policy of MFIs for inclusive financial growth All existing registered NBFCs intending to convert to NBFC-MFI must seek registration not later than October 31, NBFC-MFIs shall maintain Net Owned 5

6 Funds (NOF) at Rs.30 million by March 31, 2013 and at Rs.50 million by March 31, 2014 but those in the North Eastern Region of the country which will require NOF of Rs.20 million. Non-MFIs cannot lend more than 10 per cent of the total assets to the MFI sector. NBFC-MFIs are required to maintain not less than 85 per cent of their net assets as Qualifying Assets. Income generation activities should constitute at least 70 per cent of the total loans of the MFI so that the remaining 30 per cent can be for other purposes such as housing repairs, education, medical and other emergencies. A borrower can be the member of only one SHG or one JLG or borrow as an individual. He can thus borrow from NBFC-MFIs as a member of a SHG or a member of a JLG or borrow in his individual capacity. However, a SHG or JLG or individual cannot borrow from more than 2 MFIs. Lending MFIs will have to ensure compliance with, among others, conditionalities relating to annual household income levels (Rs. 60,000/- for rural and Rs. 1,20,000/- for urban and semi urban households), total indebtedness (not to exceed Rs. 50,000/-), membership of SHG/JLG, as well as percentage of qualifying assets and percentage of income generating asset. MFI has to be a member of at least one Credit Information Company (CIC). While the quality and coverage of data with CICs will take some time to become robust, the NBFC-MFIs may rely on self certification from the borrowers and their own local enquiries on various aspects as well as the annual household income Basel Core Principles for Effective Banking Supervision In India MFIs are not permitted to accept deposits so they are treated as non-deposit taking NBFCs and are regulated as such. Presently, the prudential norms for NBFC- MFI are along Basel-1 guidelines. They have not been permitted to change their capital requirements based on the credit rating. Corporate governance in MFIs Corporate governance is of great relevance to the financial system as a whole, and merits targeted supervisory guidance. The importance of due diligence and fit and proper criteria and corporate governance is not a new concept but is widely recognized in the financial sector. Corporate governance is a framework by which the various stake holders interests are kept balanced. The recent financial crisis 6

7 epitomized by bonuses, remuneration, excessive risk taking and irresponsible lending hence, can be seen in this respect, more of a crisis in corporate governance. The OECD in its paper on Lessons from the Crisis also concludes that the the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements which did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies." Since NBFC-MFIs are essentially financial corporates, there is a need for them have qualified directors and share holders to steer the company through all times. A fit and proper management with concomitant good corporate governance and rigorous internal control mechanisms is seen as the first line of defense to be supplemented and overseen by official supervision in the context of the increasing potential for systemic risk posed by large NBFCs and the reputational risk for them. Presently the evaluation of Management of an NBFC is undertaken mainly at the time of scrutiny of the application for Certificate of Registration. The Bank calls for information about each of the Directors of the company in a specified format with an additional form for identification particulars. The information called for provides information about the director s educational qualifications, business experience, identification and whether she/he is subject to disqualification under the Companies Act, is a defaulter, or has committed any economic offence. In addition the Bank ensures that the Directors have not been associated with a company that had been rejected earlier by the Department from registration on supervisory grounds, do not figure in the Willful Defaulters database compiled by the Bank, are not associated with any unincorporated bodies that are accepting deposits in violation of the RBI Act and are not involved in any criminal case. In order to assess their integrity and suitability, the Bank also calls for information on criminal record, if any, and violations to the sanctions applied by regulators or similar bodies besides others. Apart from this, bankers reports are obtained in respect of the applicant company, associate and group companies, and companies/entities in which the directors have substantial interest. Supervisory concerns on group NBFCs are also obtained from the Regional Offices in whose jurisdiction the group NBFC falls, especially where the directors are common. Supervisory concerns are further called from regulators of group companies such as SEBI, IRDA NHB and the government, wherever necessary. 7

8 The due diligence evaluation hence only ensures that there is nothing adverse about the Directors but that does not make them necessarily appropriate for the job. Presently NBFCs with assets more than Rs 1 billion need to comply with constitution of Risk Management, Audit and Nomination Committees as well as some regulations on disclosure and transparency. However, there are no prescriptions for qualifications for directors or a system for continuing due diligence as in case of banks. RBI has no powers for removal of a person not fit and proper. Presently there are no guidelines on connected lending or remuneration practices which are engaging regulators universally. Best regulatory and supervisory practices The best regulatory practices for banks are the implementation of Basel-III. The feasibility of bringing in a Risk Based Supervision approach, based on the risk profile of individual NBFCs is proposed at a later date. On disclosures, it is being proposed that all registered NBFCs should disclose their registration with other regulator(s) such as SEBI, IRDA, Stock Market and Commodity Exchanges. They should disclose any credit ratings assigned by rating agencies. In addition, all registered NBFCs should disclose penalties, if any levied by any regulator. NBFCs with asset size of Rs. 10 billion and above will need to comply with mandatory disclosures under Clause 49 of the SEBI listing agreement, irrespective of whether they are listed or not. Additionally, they will need to disclose their provision coverage ratio, liquidity ratio, asset liability profile, extent of financing of parent company products, NPAs and movement of NPAs, details of all off-balance sheet exposures, structured products issued by them as also securitization/assignment transactions etc. Further, in the case of unlisted NBFCs with asset size of Rs.10 billion and above, these disclosures should be made available on their websites. Amendments in Corporate Governance are being contemplated regarding change in control and transfer of share holdings, number of directorships which an individual may hold if associated with systemically important NBFCs, induction of independent directors and remuneration policies and disclosures. 8

9 It is proposed that the regulation and supervision of RBI will be supplemented by self regulation imposed by Self Regulatory Organisations. All NBFC-MFIs will have to become member of at least one Self-Regulatory Organization (SRO) which is recognized by the Reserve Bank and will also have to comply with the Code of Conduct prescribed by the SRO. Guidelines on the SRO structure will follow shortly. On liquidity, Basel III prescribes that an institution should maintain adequate levels of liquid assets which can be converted to cash at very short notice to enable it to survive a 30 day time horizon. It is proposed that to direct all registered NBFC-MFIs to maintain high quality liquid assets in cash, bank deposits available within 30 days, money market instruments maturing within 30 days, investment in actively traded debt securities (valued at 90 per cent of the quoted price) and carrying a rating not lower than AA or equivalent, equal to the gap between total net cash inflows and outflows over the 1 to 30 day time bucket as a liquidity coverage requirement. In other words, there should not be any liquidity gap in the 1-30 day bucket. International experience in regulating MFIs The Asian Development Bank (ADB) has published a Report on The Role of Central Banks in Microfinance in Asia and the Pacific in This study of the role of central banks in microfinance examines the role and operations of central banks in microfinance development in twelve developing member countries (DMCs) of the Asian Development Bank (ADB). The countries concerned are Bangladesh, People s Republic of China (PRC), India, Indonesia, Kyrgyz Republic, Nepal, Pakistan, Papua New Guinea (PNG), Philippines, Sri Lanka, Vanuatu, and Vietnam. It states that MFIs are mostly subjected to Non-prudential Regulation. Most countries have processes for registration of NGOs, cooperatives, and other institutions engaged in microfinance which do not usually involve central banks. However, there are cases where Central Banks become involved in the registration or licensing of certain categories of MFIs. On capping the interest rates to be charged to the borrowers, some countries impose ceilings on the interest rates MFIs can charge borrowers. In most cases, these are prescribed in anti-usury laws or result from the policies of various government agencies, rather than being imposed by the central bank. However, there are a 9

10 number of cases where the central bank does in fact control the interest rates charged by certain categories of nonbank MFIs. However, it is recognised that interest rate restrictions impede the development of sustainable microfinance, and it would be appropriate for central banks to remove any such restrictions within their control. Even where such restrictions do not result from central bank actions, central banks may be able to lend their prestige and influence to efforts directed at their removal. A World Bank paper A Framework for Regulating Microfinance Institutions by Hennie van Greuning, Joselito Gallardo, Bikki Randhawa was submitted in December It examines the need to regulate microfinance institutions, what activities should be regulated, who should regulate them and what issues are fundamental to the sector's regulation. The paper states that the continuum of institutions providing microfinance cannot develop fully without a regulatory environment conducive to their growth. Without such an environment, fragmentation and segmentation will continue to inhibit the institutional transformation of microfinance institutions. Van Greuning, Gallardo, and Randhawa state that there are two approaches to regulation of MFI operations: (i) internal regulation through governance and (ii) external regulation by a supervisory agency. For regulated MFIs these two approaches are closely related since the effectiveness of the second approach is highly dependent on the first. They recommend a tiered approach to external regulation, one that takes into account the different types of microfinance institutions, the products they offer, and the markets they service. The paper cautions that (i) external supervisors and regulators cannot prevent regulated and licensed institutions from failing and (ii) as facilitators of the risk management process supervisors and regulators must evaluate and enhance the statutory framework under which risk management is carried out by regulated and supervised MFIs. A paper by Patrick Meagher titled Microfinance Regulation in Developing Countries: A Comparative Review of Current Practice published in 2002 examines the lessons of experience from the countries that have begun to address the legal and regulatory framework for microfinance. The paper discusses twelve separate examples of 10

11 microfinance regulatory systems, from ten jurisdictions spanning the developing world (Bangladesh, Bolivia, Ethiopia, Ghana, Indonesia, Peru, the Philippines, South Africa, Uganda, and the West African Economic and Monetary Union). These cases are divided, into two groups one comprising MFIs that are directly regulated and supervised by the banking and financial services authorities, and one comprising institutions subject to indirect regulation (hybrid or self-regulation). Most of the systems reviewed in the paper have found ways to exclude the smallest institutions for which regulation makes little sense through either formal or informal exemptions. In almost all countries small informals and traditional rotating and credit associations are exempt de jure or de facto (the latter case is usually referred to as regulatory forbearance ). This standard protects regulators from unreasonable burdens. This paper has reviewed diverse examples of alternatives to central bank/supervisor regulation. These other options range from the combination of apex oversight and self-regulation used for NGO-MFIs in Bangladesh and the Philippines to the varied systems of shared oversight in the other countries, which involve centrally determined regulatory standards and supervision by other entities. The entities include federations of MFIs (in Peru and UEMOA), financial institutions that are parent companies of MFI networks or delegated supervisors (Indonesia and UEMOA), and authorized private regulators in systems where MFI registration with such an entity is mandatory (South Africa). Experience has been varied, with delegated supervision achieving good results, creditor and apex oversight leading to mixed outcomes, and self regulation performing worst. These outcomes are to be expected, although they are neither fully consistent nor inevitable for example, a capable apex might perform better than a badly designed scheme of hybrid regulation and supervision. Conclusion: In India the regulation and supervision of the sector is still evolving. The Microfinance Bill is pending in the Parliament and the future of the sector will be shaped by the regulations as proposed in the Bill. 11