Responsible Lending

In a globalised world with a high degree of transparency and information flows, socially and morally appropriate behavior is becoming increasingly important for all market participants. Responsible Lending has become a catchword in financial system development.

International scenario

Over the past few years, the microfinance sector in developing countries has experienced enormous growth rates. Enterprises and the people in general in many developing countries now have significantly better access to financial services. This has contributed to economic growth and greater prosperity, including among relatively poorer groups of the population. Yet, despite these positive impacts, the upward trend has also shown its downside and created new pressures of competition and sharper expectations which must be addressed, to ensure that the sector achieves its potential and the desired growth rates. These include a range of issues associated with the legal and regulatory framework, transparency and fair practices, ownership structures and corporate governance, institutional & operational capacity, sustainability of operations etc.

Indian Perspective

The micro finance sector in India has witnessed exponential growth, particularly in the last two years. Today, the top 10 MFIs account for around 70% of the market share. The growth has created new pressures of competition and sharper expectations to surpass the standards reached by the MFIs. Managing this growth is the need of the hour. Thrust towards Responsible financing and self regulation by all the stakeholders in the sector is undoubtedly a timely and welcome step.

Responsible Finance includes practices designed to create a fair balance of interests between MFIs and its customers, employees and business partners on the one hand and with their shareholders and refinancers on the other hand. Hence, it affects all market players and cannot be reduced merely to the relationship between an MFI and its customers. 2

The four dimensions of responsible finance are-

1. Customers

2. Micro Finance Institutions

3. Regulatory authorities and

4. Donors

1) Customers

• Customers meaning the ultimate beneficiaries should be capable of understanding the fundamental aspects of financial services, particularly debt relationship. Hence, educating them and strengthening their confidence in the financial sector becomes imperative
• In the microfinance sector, the field level practices employed by MFIs are still weak in some areas. The MFIs need to educate the ultimate beneficiaries about the pricing mechanism in the manner and language which is simple and easily comprehensible

2) Micro Finance Institutions

• Amidst growing competition, the sector faces the challenge of matching necessary growth with sound lending practices and good governance which would give confidence to shareholders, donors, governments, regulators and lenders. Effective governance ensures transparent operations and a balanced growth
• The MF sector is an emerging industry which is expanding at breakneck speed. The two biggest problems identified are lack of corporate governance and issues related to transparency.

Corporate Governance

• The need for governance arises to ensure effective management of MFI and to attract people with much needed skills. MFIs mostly in the Tier 2 and Tier 3 category need to establish high standards of corporate governance in order to sustain the pressures induced by high growth. This would ensure transparent operations and balanced growth
• Barring a few MFIs, most MFIs still do not have independent members on their Board. Having a Board with members drawn from diverse fields of 3 expertise would not only help in getting more professional and strategic inputs but would also lend credibility to their entire set-up
• Further, with increased scales of operations, MFIs will need to develop impersonal management systems so that the operations are not leader driven, but are systems driven

Transparency

• In the micro finance sector given the phenomenal growth rates, it is not surprising that MFIs in India eagerly report their impressive outreach figures – rising numbers of borrowers, greater loan volumes, ever expanding geographic penetration. However, besides a small number of leading Indian MFIs, few institutions follow rigorous accounting and reporting procedures based on international standards resulting in Transparency Deficit
• The four most commonly cited sources of weak MFI financial transparency are portfolio quality reporting, loan loss provisioning, donation accounting, and loan liability accounting
• MFIs often drastically inflate their profitability by pooling donation revenues together with revenues from their normal operations. To assess an MFI’s long-term sustainability, stakeholders must be able to gauge an institution’s financial performance excluding donation inflows. To achieve this, ideally the income statements of the MFIs should clearly distinguish between operational revenues and non-operational revenues such as grants / donations and should also explain the grant recognition policies
• As in other key accounting areas, NGO-MFIs have far more heterogeneous loan liability re-porting practices than their NBFC counterparts. Loan liability accounting and reporting is, therefore, another key driver of the NGO-MFI transparency gap
• Also there is an urgent need for sharing information amongst the players in the sector on the growth of the microfinance sector indicating the break-up State-wise/ Region-wise/ district-wise etc. to effectively monitor and channelize the resources to relatively underserved areas

3) Regulatory authorities

• The regulatory authorities should ensure effective implementation of policies so as to protect the interests of both the lenders and their clients
• Also the accounting and reporting policies must aim at narrowing the transparency gap to reduce the administrative cost to the MFIs and supervisory cost to the regulator.

4) Donors and investors

• Keeping in view the large investments in the sector fuelling rapid expansion, donors and investors can contribute by engaging in long-term commitments, promoting good governance and by using their instruments in line with the needs of the institutions they support

In the end it can be concluded by saying that responsible borrowing facilitated by financial literacy and responsible lending by financial institutions will lead to financial stability among the consumers and ensure the objectives of financial inclusion are fulfilled.

Written By

Garima Shukla

PGDM II

IMI, New Delhi