M-FIN and Sa-Dhan, two key Self-Regulatory Organisations (SROs) of the microfinance industry jointly released their revised Code of Conduct for the Microfinance Industry in December 2015. The revised Code of Conduct following from the original 2011 version, is vital for setting standards of behaviour and maintaining norms through collective action[1], with a view to uphold client protection in the industry in line with and in some aspects beyond regulatory statutes.
In this post, a few salient and commendable features of the revised Code of Conduct are highlighted, alongside potential concerns and recommendations.
Transparency:
This section features an important commitment to “disclose all terms and conditions to the client, in a form and manner that is understandable, for all services offered.” It further indicates a commitment to securing clients’ informed consent and communicating details in a language understood by the client. These details include simple concepts such as all associated fees and charges but also more complex aspects such as interest and fees payable as an all-inclusive Annual Percentage Rate (APR) and equivalent monthly rate. This is in line with the RBI Guidelines for Fair Practices Code for NBFCs[2].
However, given the sometimes complex aspects of information that are imparted to clients, there is necessity for MFIs to better ensure truly informed consent based on demonstrated customer understanding. This could be implemented, for instance, in the form of a short verbal quiz about product features and obligations to be administered to the client at the point of sale based on some rules of thumb.
Avoiding over-indebtedness:
The sub-section on over-indebtedness is an important part of the Client Protection section.
It includes a commitment to “conduct proper due diligence as per [the MFI’s] internal credit policy to assess the need and repayment capacity of clients before making a loan and must only make loans commensurate with the client’s ability to repay”. This addresses a key aspect of preventing bad outcomes by verifying that loan clients are able to afford paying back the principal and the interest by the end of the loan tenure. Given the critical nature of this commitment, there is also a necessity to put in place a commitment for a Board-approved policy to ascertain client ability to repay and prevent financial distress. This would be in line with the RBI Charter of Customer Rights[3] and the IBA Model Customer Rights Policy[4] which includes a commitment to prepare Board-approved policy incorporating the Right to Suitability, stated as “products offered should be appropriate to the needs of the customer and based on an assessment of the customer’s financial circumstances and understanding.”
There is a concern that this does not however include a commitment to ascertain whether clients are able to make repayments without substantial financial stress throughout the tenure of the loan. For instance, liquidity mismatches between structured instalment frequencies (typically weekly or monthly) and household cashflows could lead households to take on additional loans from informal sources or sell off assets such as livestock or land at below market prices, even though such households are comfortably able to repay the loan by the end of the tenure. This concern is exacerbated by the absence of adequate savings mechanisms for MFI clients, who are oftentimes unable to safely put away relatively large sums of money for future use. There is thus a necessity to enhance the nature of MFI due diligence for better client outcomes. There is also a necessity for a commitment to design and distribute products that are appropriate and flexible to address the needs and financial situations of customers, while preventing financial distress. This is in line with the RBI Master Circular on Customer Service in Banks which indicates the role of a Customer Service Committee of the Board to address the product approval process “with a view to suitability and appropriateness.”[5]
The sub-section also includes a commitment for an MFI not to exceed the borrowing limit of Rs. 60,000 for a JLG customer (which is lower than the RBI mandated total indebtedness cap of Rs. 100,000)[6] in a group arrangement or to be the third lender to a client. There is a concern that such caps on lending might be restrictive to households that might have a genuine need and ability to repay higher loan amounts. Moreover, there does not seem to be clear basis for both cap values, especially when MFIs are already committing to conduct proper due diligence on client need and repayment capacity of every client.
There is an additional concern that customer data from credit bureaus may not provide a complete assessment of overall household indebtedness. Credit institutions are yet to fully act upon RBI’s requirement[7] to report to all credit bureaus, especially in terms of loans from the bank and SHG channels, although there has been steady progress[8]. Credit bureau data is also, at best, unable to include household debt outstanding from informal sources such as local moneylenders. There is thus a need for a commitment to better understand customer indebtedness and financial situation through customer self-reported information, which when triangulated with credit bureau information can provide a more complete assessment of household indebtedness.
The sub-section includes important commitments with regard to authenticating client identity and sharing client information. The move towards Aadhaar-based KYC within two years will commendably enable more accurate credit bureau assessments of outstanding debt. The challenges of implementing a seamless KYC interface will need to be overcome with robust yet low-cost technology solutions that enable error-proof and real-time authentication.
Governance:
The new Code of Conduct lays out commitments to have in place several Board-approved policies for debt restructuring, dealing with delinquent clients, fair collection practices, and processes to raise client awareness. Board-approval is valuable for putting in place policy for important client protection aspects that is pervasive across all levels of an MFI. This is therefore a very progressive development.
There is also a commendable commitment to prepare a monthly report on grievances received, resolved, and pending for senior management review and periodic reports to the Board. However, by the same rationale as the commitment on audit and compliance, there needs to be an additional commitment for appointing an independent grievance redressal committee that is directly accountable to the Board. This is in order to prevent a potential conflict of interest that operations staff could face leading to under-reporting of customer grievances.
Customer rights:
The new Code of Conduct also includes an important section that outlines the rights of a customer, in addition to commitments from participating MFIs, in similar vein as the RBI Charter of Customer Rights[9]. There are customer rights outlined to ascertain terms and conditions and current status of the loan and avail necessary documents and receipts, which are in line with the RBI’s Right to Transparency, Fair and Honest Dealing. There are also customer rights outlined to access a grievance redressal mechanism with the help of designated staff, receive acknowledgment and a response to grievance within a prescribed time limit, and appeal to a higher internal level or an external redressal mechanism (the nodal office of the RBI) if desired, which are in line with the RBI’s Right to Grievance Redress and Compensation. Other rights outlined in the RBI Charter, including the Right to Fair Treatment and Right to Privacy are included as commitments to customers, although given their relevance, need to be included as rights as well. Finally, there is a need for a stronger commitment and customer right to Suitability.
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[1] SEEP Network – Codes of Conduct and the Role of Microfinance Associations in Client Protection (2012): http://www.seepnetwork.org/codes-of-conduct-and-the-role-of-microfinance-associations-in-client-protection-resources-345.php
[2] RBI Master Circular – Fair Practices Code (July 2015): https://rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9823
[3] RBI Charter of Customer Rights (December 2014): https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=32667
[4] IBA Model Customer Rights Policy (January 2015): http://www.iba.org.in/Model%20Policy/Model_Customer_Rights_Policy_Amended_Final_27_1_15.pdf
[5] RBI Master Circular on Customer Service in Banks (July 2015): https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=9862
[6] RBI Master Circular on PSL Targets and Classification (April 2015): https://rbi.org.in/Scripts/NotificationUser.aspx?Id=9688&Mode=0#ANN
[7] RBI Directive on Membership of Credit Information Companies (CICs):
https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=9485&Mode=0
[8] Article on Livemint (August 29th, 2015): http://www.livemint.com/Industry/FRgAFR9Clo3nvMCdGFl37L/MFI-credit-bureaus-comb-client-data-to-smooth-microloans.html
[9] RBI Charter of Customer Rights (December 2014):
https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=32667
2 Responses
On the CoC itself:
It’s excellent that the CoC is a joint product from Sa-Dhan and AMFI. Also that it’s clearly stated that the recommendations in the CoC are supplementary to the official regulations, and do not in any way replace them. Just about every industry association, everywhere, has codes of conduct of some sort, which tend to be honoured more in the breach than the observance, but at least this one has the imprimatur of both the industry associations.
And in India, of course, there are vast and sadly all too durable gaps between what really happens and the very comprehensive laws on such things as child labour and dowry; it is all too easy to make pronouncements, codes of conduct and even laws which are thereafter ignored, but reforms have to start somewhere.
On specific items:
The aadhaar system is deservedly admired, world-wide, for its coverage and technical sophistication, but I doubt whether the poorest people, migrants living beneath flyovers in plastic tents, women who are not allowed out of their slum huts, and so on, will have their own cards within two years, or even in this generation. Will this requirement, however well intended, effectively exclude those who are most in need ? Or, it may be that such people should not in any case be in the microfinance target market, micro-credit (i.e. micro-debt) is not what they need; that is, however, another argument, and so long as MFIs believe they are reaching the ‘poorest of the poor’ the code of conduct should not prevent them from doing so.
On transparency, the requirement that everything should be ‘in writing’ is sadly laughable, given the illiteracy rates among poorest people and of course women in particular. The need to use local languages is similarly unrealistic; many poor people, tribal women in particular, speak only tribal languages, some of which are not written down at all. I like your suggestion that MFIs should be required to use some kind of quiz to demonstrate client understanding. Please may IFMR design and test such a thing, or rather several hundred such things, given the plethora of local languages.
And please share the quiz and the Code of Conduct with payday lenders here in the UK and in USA, with a few more variants in Spanish, Somali and so on. Millions of relatively poor but literate people here borrow money from such lenders, every day, where the annual percentage rate of interest is prominently displayed in large letters on website, posters and so on. See http://www.quickquid.co.uk , 1270% APR, there are many more.
The distinction between individual client and household indebtedness is fuzzy; you are so right to point it out but it is very difficult to figure out which is which. As with so many of these issues, what is really needed is sensitive local informal understanding, not boxes to be ticked in official codes or regulations, but the trend everywhere is to to be formal and measurable and, maybe, to be heartless.
And finally, your comment about the commitment to develop new products which will help people to cope with the reality of their cash flows is excellent; I’d go further, drawing on Stuart Rutherford’s work in Dhaka (see his ‘The Poor and their Money’, PA Publishing, Rugby 2009) and on Bandhan’s new status as a ‘real’ bank, and demand that all MFIs should within two years offer and genuinely promote demand deposit services, with very low minimum deposit, withdrawal and balance requirements. They won’t make profits, but it can and must be done, whether traditionally, as by SBI or KBSLAB, or through correspondents or on phones, as is done in East Africa.
Sir, you have brought up some very pertinent points. I would like to share our experiences from monitoring visits of IFMR Capital in this regard:
(i) On transparency – effectiveness of written communication and local languages:
In various monitoring visits to MFI-borrowers, it is often observed that borrowers have relatively fair understanding of the interest rates in a way that is more comprehending to them. Quite often, we see borrowers referring to interest amount charged in terms of per rupee borrowed – for example – INR 1.4 is to be repaid for every INR 1 borrowed. We also observed frequent instances of borrowers referring to differential interest rates charged by banks with MFI operations and MFIs only and their willingness to opt for credit from lower interest charging institutions. It is also observed that members were able to recollect and refer other expenditures that have been incurred for availing the loan as ‘cost of borrowing’, like, insurance fees, processing fees (even transportation charges, at times) –which are indicative of IRR. This awareness is largely because of the effectiveness of communication made by the field staff in local languages. Borrowers understand the terms and conditions better, when it is communicated in local language and communication happens in multiple ways and at various frequencies – spoken communication during CGT, GRT, disbursement and collection meetings, written communication in loan card. Many micro-lending institutions also provide literacy and numeric training to woman borrowers as a part of their regular lending process. We have also observed instances where borrower’s children/younger kith and kin the family, are reading the information mentioned in the loan card (like insurance details, instalment amount) and communicating the same to the borrower. While written communication seems sadly laughable now, we believe that, increasing literacy rates (financial literacy specifically), especially among women, will help reap in the real benefits of written communication in near future.
Written communication on product and pricing details, grievance redressal number and detailed terms and conditions, as of now, helps us; the external agencies and visitors, better understand the awareness level of borrower.
(ii) On authenticating client identity and over-indebtedness:
MFI’s outreach and intention to serve the economically active “poorest of the poor” is often subject to availability of social collateral, which is defined by networks and connectedness among borrowers; membership of more formalised groups; relationships of trust, reciprocity and exchanges. It is an asset which requires understanding of each other’s living pattern, economic conditions, state of household cash flows and overall household indebtedness level etc. to grow its base. Social collateral is an indicator of stability and reliability for the MFI-client. As long as borrowers are able to offer the required collateral, absence of identity proofs like Aadhar card etc. should not deter MFIs to provide credit services to its target borrower segment. While the segment with no Aadhar card, will be significantly low as compared to the larger target market size, MFI might need to design new products (may be shorter tenure product etc.) or might have to remain flexible in accepting various KYC details apart from Aadhar card. For the segment, which qualifies as MFI target customer and are unable to provide Aadhar card details, MFIs might have to resort to unconventional ways of finding overall household level indebtedness as a risk management strategy.