By Charitha Ratwatte –
Confusion in Batticaloa
The dynamic development of Microfinance (MF) worldwide continues. The Reserve Bank of India (RBI) recently created history, by granting for the first time a banking license to a microfinance organisation – Bandhan Financial Services.
Bandhan was set up in 2001, based in Kolkata and works with ‘socially disadvantaged and economically exploited women’. It has 2,016 branches across 22 states. In February 2014 Bandhan had over 5,233,000 borrowers and in February 2014 had disbursed Indian Rs. 963 crores of loans. The total loans outstanding are Indian Rs. 5,704 crores.
The RBI in a statement said that it had assessed the quantitative and qualitative aspects of the application, including Bandhan’s financial statements, 10-year track record of running a financial services company, proposed business model and demonstrated capabilities, when deciding to grant the ‘in principle’ license.
Bandhan’s Managing Director said that the award of the banking license was recognition of the microfinance sector and the hard work to reach out to unbanked sectors by Bandhan. Now Bandhan will be able to offer fully-fledged banking services to the poor and marginalised.
MF reputation under attack
The reputation of MF has been under attack recently, especially on the issue of over-borrowing and resultant over indebtedness by MF clients. However a recent comprehensive study of 3,000 households in eight villages over a 20-year timeframe, released by the World Bank (Dynamic Effects of Microcredit in Bangladesh), has rehabilitated MF and established that: ‘there is no evidence that borrowing from multiple sources leads to over indebtedness’ and that ‘MF loans do benefit women more’. In fact the report concludes that access to ‘multiple credit institutions encourage households to diversify their income earning activities’. The fact that MF helps the poor is confirmed.
Meanwhile on 7 April, in Sri Lanka, the Secretary to the Ministry of Finance Dr. P.B. Jayasundera delivering the first Dr. W.M. Tilakaratna Memorial Lecture on ‘The Contemporary Thrust of Sri Lanka’s Development Strategy,’ referred to the consolidation of nine regional development banks into one institution, which was dedicated primarily to women entrepreneurs.
He also made a reference to the ‘strengthening of micro financial institutions’ in the course of his lecture. Details were not provided, but reports on the ongoing consolidation of the financial sector talk of dedicated Microfinance Institutions (MFI) and proposed legislation for regulation of MFIs are possibilities.
But the role of microfinance as a developmental tool for poverty alleviation has its detractors. Hugh Sinclair, in ‘Confessions of a Microfinance Heretic,’ provides an analysis of what the purposes of microfinance is, what positive outcomes it leads to, and what can be done to make it work better. David Rodman in ‘Due Diligence’ argues that ‘Microfinance is only now being subjected to genuine vigour in its analysis of outcomes, there is little evidence that microcredit has a poverty alleviation effect, but that there are foundations to be built upon’.
Sinclair is also thought to be the anonymous source of the New York Times expose on corruption within the microfinance industry. On the other hand Milford Bateman in ‘Why Doesn’t Microfinance Work’ argues that microfinance by its very nature supports only the simplest, least productive and lowest growth potential activities.
Most loans are in fact simply used for consumption, which the World Bank’s Consultative Group on Poverty (CGAP) recognises implicitly in its attempts to redefine microfinance in terms of financial inclusion, ignoring the issue of the micro loans sustainability. This is linked in turn to the danger of over-borrowing and over-indebtedness, which was brought in stark terms in Andhra Pradesh, and by the farmer suicides, which resulted in politicians and administrators going overboard in attempting to control microfinance institutions. This resulted in negative consequences for the microfinance industry and the Reserve Bank of India presenting a draft Microfinance Bill to the next session of the Indian Parliament.
Jacques Toureille, General Manager of the Aga Khan Foundation, says ‘since the 1990s micro financing of small businesses has started to become big business… these social funding institutions are established as microfinance banks… they’ve been making a lot of money over a short period of time, getting extremely high returns and making a very large margin.’
Probably reflecting these concerns, the District Secretary (DS) of the Batticaloa District in the Eastern Province of Sri Lanka, summoned a meeting of Micro Finance Institutions (MFI) operating in the District on 1 April. A representative of the Central Bank was also present.
Representatives of MFIs present at the meeting say that the DS declared that Non Government Organisations shall not implement MF services in the district. Organisations which do not have permission from the Central Bank shall not implement MF programs. The DS also is reported to have stated that a Registration Certificate of a Company shall not be treated as license for the provision MF services.
On 4 April the Director Planning , Batticaloa District Secretariat issued a series of guidelines under reference BT/DPS/FFP/Micro 2014 by which, among other things, the maximum rate of interest for ‘micro credit activity’ was fixed at 12% per annum. Further the letter stated that MFIs have to work with the GA’s approval and with Divisional Secretaries’ recommendation.
The letter banned weekly collection of instalments. The MFIs were advised to avoid ‘duplication of beneficiaries’. Each and every MF loan should be recommended by the Div Sec. The MFI ‘should be registered under Central Bank’s Guidance’. Individual house visits to collect loan instalments or to evaluate loan application were not allowed. All NGOs in MFI activities should get special permission for MF activities. MF loans for consumption were prohibited. It is nowhere stated under what legal authority the Government Agent/District Secretary has issued these orders.
The Lanka Microfinance Practitioners Association (LMFPA), the apex organisation, took this issue up with the authorities in the Ministry for Economic Development and it was suggested that a meeting be held to discuss the matter with the District Secretary, Batticaloa. Newspapers reported the crisis faced by both lenders and borrowers in the Batticaloa District by the sudden imposition of these draconian rules, most of which have no legal basis.
However on 7 April 2014, the same Director Planning, of the Batticaloa District Secretariat issued a letter, reference, DPS/NGOC/GENRL/2014, captioned ‘Special Approval for Micro Finance Projects,’ stating that ‘special approval’ is required for MF projects in the Batticaloa District. It also requested MFIs to which it was sent ‘to submit a list of selected beneficiaries and the registration copy of the Central Bank which is saying that you are entitled to implement Micro Finance activities’.
The letter also refers to a ‘Concept Note’ annexed. This so-called ‘Concept Note’ seems to be a form to be filled in by MFIs and submitted to the Government Agent, through the Divisional Secretary and the Director Planning. On a plain reading it is, beyond doubt, one of the most meaningless documents ever to emanate from a District Administration. While it is beyond comprehension by a reasonable person, it simply cannot be filled in a meaningful manner!
It is reported that most MFIs have suspended operations in Batticaloa District. The LMFPA has written to the DS Batticaloa and requested an early meeting to resolve this crisis. On 23 April the LMFPA met the DS Batticaloa, the outcome is not yet known.
No regulatory mechanism in place
This situation has come about currently in Sri Lanka today due to the fact MF seems a lucrative profit centre among financial service providers, but there is no regulatory mechanism in place.
All financial service providers ranging from licensed commercial banks, finance companies, Non Government Organisations, cooperatives, money lenders, pawn brokers, cheetu schemes (Rotating Savings and Credit Associations [ROSCAs]), registered voluntary social service organisations, registered societies, Government programs, etc. are all promoting themselves as providers of MF to the poor and the marginalised. Many of these are glorified hire purchase schemes at very high interest.
The popularity of microfinance may have been triggered by Prof. Yunus of Bangladesh being awarded the Nobel Peace Prize for his work with the Grameen Bank of Bangladesh, the first MFI to be granted a banking license. Ironically, since then, the Government of Bangladesh through its Central Bank has ousted Prof. Yunus from the Grameen Bank. The Government is appointing his successor. Another success going down the drain? The politicians in Bangladesh seem unable to forgive Yunus for trying to start a rival political organisation some time ago!
Sri Lanka’s history of microfinance
Sri Lanka has a very long history of microfinance; the first cooperative rural bank took in savings deposits and gave out its first small loan, what is today fashionably referred to as micro credit, in the early 1900s at Menikhinna, in the Kandy District.
The Government has from time to time promoted microfinance, for example through the Central Bank’s Isuru Project, the Janasaviya Trust Fund (JTF) and its successor, the National Development Trust Fund (NDTF). The Sri Lanka Savings Bank now has a special window for wholesale lending to microfinance institutions, using the NDTF loan repayment funds, after the latter was wound up. The current incarnation is Divi Neguma.
The Act defines microfinance as: ‘A type of banking service that is provided to employed or low income individuals or groups, who would otherwise have no other means of gaining financial services.’ This is the only legal definition available in an enacted law. The definition is far from satisfactory. For example, the ‘unemployed’ are not eligible for microfinance. One recent estimate put the number of MFIs at 16,400. Microfinance has an important role to play in gender empowerment in Sri Lanka as it is estimated that over 70% of depositors and borrowers are women.
In Sri Lanka’s recent history of the financial services sector, there have been some spectacular lapses in prudential regulation, which has resulted in depositors losing money. Starting from the crash of HPT, UTI, the collapse and takeover of Mercantile Credit, to Pramuka Bank, to Sakvithi, to Danduwan Mudalali (deceased) and Dadi Danduwan Mudalali, Ceylinco Shriram, and the Golden Key episode, the financial regulator has been found wanting.
A recent newspaper headline screamed ‘Central Bank’s Failure on Golden Key Comes to Light’ in block capitals, with the lead story in multicolour! One witness before the PSC on the CJ’s impeachment is reported to have stated that the ‘Monetary Board discontinued the investigation’.
While the Central Bank of Sri Lanka is the primary regulating authority for banking and financial services, the Commissioner of Cooperative Development at the national level and his Provincial counterparts, the Registrar of Companies, the regulators under the laws governing ROSCAs (cheetu), money lenders, pawn brokers, insurers and all other legally-recognised providers of financial services have designated regulators, under which the institutions under their purview have been set up.
The Central Bank, recently under the caption Microfinance Institutions, has stated: ‘The CBSL was involved in preparing legislation for the regulation of microfinance institutions. There are several categories of microfinance institutions that are registered under various laws, but are not regulated or supervised according to prudential criteria. Hence, to safeguard the interest of depositors and customers and also to strengthen the governance and service delivery of these entities, it was decided to bring them under a common regulatory umbrella.’
In terms of a Microfinance Bill, hereinafter referred to as ‘Draft Bill No. 03’ on microfinance announced recently, as having been approved by Cabinet, the Monetary Board of the CBSL is the regulator for MFIs. This is a welcome step.
In Sri Lanka although there is no legal definition as to what specifically falls with the definition of ‘microfinance’ (except in the Divi Neguma Act), the Draft Bill No. 03 provides a definition, differing from the Divi Neguma definition. In Part II Section 10(2) of the draft law it is stated that ‘microfinance business’ is ‘the acceptance of deposits and providing financial accommodation any form and other financial services mainly to low income persons and micro enterprises’. The Draft Bill No. 03 on regulating microfinance limits its application to certain companies, Non Governmental Organisations and societies. The Bill also provides that the Bill will not apply to licensed banks and finance companies.
Further in terms of the Finance Business Act No. 42 of 2012, which places restrictions on the freedom to use the word ‘finance’ and all its derivatives in a company name, among other things, the Communications Department of the CBSL has issued a press release from the Department of Supervision of Non Bank Financial Institutions, stating among other things that, over and above the exemptions provided in the Act itself, by section 10 (6): ‘The Monetary Board has approved that any company/organisation which has been carrying on microfinance business and registered under the following statutes as at the effective date of the Finance Business Act No. 42 of 2012 may continue to use the word ‘microfinance’ as a part of its name or description until such time the proposed Microfinance Act is enacted.’
The Finance Business Act does not provide for a provision under which such an order can be made by the Monetary Board, virtually negating the provisions of the act. The statutes are (a) a company registered under the Companies Act No.07 of 2007, (b) any NGO registered under the Companies Act No. 7 of 2007 and Voluntary Social Services Organisations [VSSO] (Registration and Supervision) Act No. 31 of 1980, (c) any Society registered under the Societies Ordinance (Chap.123).
This amounts to virtually amending the act, and the legal basis for doing so is not explained. In any event the effect of this decision is to permit certain institutions which do not presently come within an acceptable framework of prudential regulation from an aspect of a provider of financial services to the general public to continue to undertake microfinance business.
Very high risk strategy
Given the weak and ineffective history of the regulators in Sri Lanka, including the extra legal steps taken by the DS Batticaloa, in imposing restrictions on MF, which have no legal basis, this is a very high risk strategy, putting the public at large in jeopardy of being defrauded by unscrupulous elements.
For example, the VSSO and Societies Ordinances provide for a regulator but these bodies do not have the capacity to provide a sufficient level of prudential regulation of the financial services provided by these entities. The Draft Bill No. 03 on MFIs categorically places these institutions under the regulatory regime of the Monetary Board of the CBSL.
The Draft Bill No. 03 sorts out the problem of determining what type of MFIs are covered by the Bill by specifying that only the entities specified in the bill can apply for a license. But while the Monetary Board directly regulates licensed MFIs, Samurdhi, Cooperatives and Farmers Banks are regulated by their relevant regulators on directions issues by the Monetary Board in terms of the Draft Bill No. 03. The Draft Bill No. 03 provides that the Monetary Board has the power to issue directions to the Commissioners of Cooperative Development, the Samurdhi Authority and the Commissioner of Agrarian Services.
It is interesting that the recently-enacted Divi Neguma Act which took over the Samurdhi Banku Sangams and renames them Divi Neguma Banku Sangam, provides that the Banking Act and Finance Business Act will not apply to the Divi Neguma institutions. So, no prudential regulation of Divi Neguma micro finance? In the Divi Neguma Bill, the definition of microfinance differed from that in Draft Micro Finance Bill No. 3.
At the briefing of the press on the meeting of the Cabinet of Ministers which approved the Draft No. 03, MFI Bill, it was stated that a three-tier system was being adopted in Sri Lanka, certain MFIs directly by the Monetary Board, others through officials like the Commissioners of Cooperative Development and a third category by registered auditors acting on behalf of the CBSL.
MFIs in Sri Lanka for decades received subsidised funding from the Janasaviya Trust Fund and its successors, the National Development Trust Fund and the Sri Lanka Savings Bank. With the ongoing consolidation of the financial services sector, the future of this MFI window of the SLSB is not known.
Need for prudential regulation
The discussion on the first and second draft bills on MFIs in Sri Lanka has resulted in the Draft Bill No. 03 being a great improvement on its predecessors. The CBSL itself has admitted that ‘several categories of microfinance institutions that are registered under various laws, but are not regulated or supervised according to prudential criteria’.
Whatever the controversies, at a global intellectual or at operational level, in places like Batticaloa District, the fact remains that microfinance is a financial instrument, which almost all financial service providers in Sri Lanka are presently utilising. The Central Bank itself has recognised the need for prudential regulation. Give the rampant scandals in the financial sector of late, leaving the microfinance sector unregulated is a high risk strategy, which, if at all, compounds the dangers, which micro savers and micro borrowers face.
As has been pointed out, this sector is not a new development but has a long history, going back to the 1900s. The continued lack of prudential regulation is a betrayal of the legal and moral obligation of the regulator of which cognisance must be taken at the highest level, including the higher judiciary which has to ensure the rule of law.
In this context, the early enactment of the Draft Bill No. 03 on micro finance regulation would be welcome. However the conundrum caused by Divi Neguma being exempted from both the Banking and Finance Business Acts raises major new issues regarding the prudential regulation of the sector. The confusion caused in Batticaloa District by orders issued by the DS must also be remedied.
Notwithstanding these issues, Divi Neguma has launched its micro finance window. It will be good if Divi Neguma provides the space for pre existing MFIs, said to be around 16,400, to continue to operate and may be also support these MFIs through the Divi Neguma Development Fund and the Divi Neguma Revolving Fund.