Author: Daniel Rozas

Last week, MFIN, received official recognition from the Reserve Bank of India as a Self-Regulatory Organization in charge of regulating the activities of its members. This is the first time a financial organization received such official recognition in the country. Indeed, I'm not aware of any other countries that have a similar arrangement, so this may well be a global milestone as well. 

This is a big deal that bodes well for the future development of the Indian microfinance sector. It also reminded me of an article co-authored by M-CRIL's Sanjay Sinha and myself back in January 2010, nearly a year before the onslought of the Andhra Pradesh crisis.  MFIN had been formed just months before, and had developed a Code of Conduct that included many important features, including strong limits to multiple lending - a maximum of 3 concurrent loans or combined amount of 50,000 rupees (~€750 at the time). However, we felt that as a purely self-regulatory institution, MFIN lacked the teeth to effectively monitor its members, and we made the case for a system quite similar to the one that's just been implemented in India.  I look forward to seeing it thrive and set an example for others. 

Here's an excerpt from the original article:

We welcome the efforts of the leading MFIs and hope the overlending limits they will be implemented quickly.  However, we are somewhat concerned about the long-term viability of the framework that is being set up.  Self-regulation is notoriously difficult and fickle.  Current market conditions certainly create incentives for leading MFIs to comply with MFIN’s standards, but situations change quickly and memories fade fast, while the business imperatives to maintain or grow market share never let up.

How will MFIN monitor its members?  What enforcement mechanisms will it have to insure adherence, and will these include exposing offenders – a threat that is essential for compliance?  And what happens when outside actors, not bound by its rules, begin to chomp at MFIN members’ market shares?  It may seem an unreasonable concern, as MFIN currently represents the overwhelming majority of the microfinance market in India, but that may not be the case for very long.   Let’s remember that it was the growing market share of new actors in the US mortgage market – Bear Stearns, Lehman Brothers and others – that undermined long-established industry underwriting practices, causing a downward market shift that helped feed the housing bubble.

These are questions not unique to MFIN, but that apply to any self-regulatory body where the nature of regulation comes into direct conflict with near-term business imperatives.  As a rule, such structures can easily lose their teeth once clearly visible risks sink back under the surface.  Moreover, what makes MFIN’s work particularly difficult is that its present objective – to prevent overlending – is a long-term one.  Much like the assets and liabilities of MFIs, the impetus and purpose of self-regulation must also be matched; otherwise enforcement can prove especially difficult.

That is the reason why most financial regulation is after all done by government.  Certainly, we don’t want to suggest that MFIN’s efforts should be supplanted by the Reserve Bank of India (RBI) or another government entity, as it would effectively slow the necessary learning and innovation needed to implement such regulation.  However, there is a middle ground – RBI, which already oversees the NBFC MFIs that comprise MFIN, could promulgate general objectives (such as limiting overlending) and delegate to MFIN the formulation and implementation of the regulatory policies required to meet them, reserving the right to withdraw this delegation if it deems necessary.  By doing so, it would retain the critically important threat of government action, thus giving lasting teeth to the self-regulatory body.  At the same time, it would foster more rapid development, better innovation and ultimately more effective regulations than it could develop on its own.  Moreover, with such official imprimatur, MFIN’s standards could also become legitimate requirements for all MFIs, not just its members or other NBFCs.  We recognize that this would represent a significant departure from the normal regulatory practices of RBI, but microfinance is not a normal financial market, and is very much in need of effective, innovative regulations that at present only the market participants themselves could devise and implement quickly enough to avoid the pitfalls of further overlending.

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