Micro finance: As India moves forward, Sri Lanka stagnates

The Reserve Bank of India (RBI) has decided to create a separate category of Non Banking Financial Company – Micro Finance Institution (NBFC-MFI). This implements a recommendation of the Malegam Committee Report on Micro Finance in India, which was appointed subsequent to the MF crisis due to indebted farmer suicides in Andhra Pradesh.

The NBFC-MFI should maintain an aggregate margin cap of not more than 12%. Interest on individual loans should not exceed 26% per annum. Processing charges should not be more than 1% of gross loan amount.

The NBFC-MFI will only be allowed to recover the actual cost of insurance of borrower’s asset or life or health. NBFC-MFI are permitted to lend to individual borrowers and are not limited to lending to self help groups. Creating this new category of MFI has been hailed by the micro finance industry in India as a giant step forward in India’s march toward total financial inclusion.

Micro finance in Sri Lanka

Some time ago in Sri Lanka a new Draft Bill of Micro Finance was made public. To date this has not been enacted into law. That is why the MF sector stagnates. It provides for the establishment of an Authority (MRSA) for the purpose of licensing, regulation and supervision of micro finance business among other things.

The recent Finance Business Act prohibits any deposit taking of all kinds, except certain categories already recognised by law, and the MRSA bill will enable micro finance institutions to continue operations accepting deposits. However the bill has not been made into law.

The MFIs, especially those which took deposits earlier, now operate in a legal lacuna. This is worse than stagnation, it is a retrograde step. Some MFIs are converting themselves into finance companies, which takes them away from the outreach role they have hitherto been playing in empowering the poor and the marginalised.

Micro Finance Bill

Part II Section 10 (2) of the bill defines a micro finance business as the ‘acceptance of deposits and providing financial accommodation in any form and other financial services mainly to low income persons and micro enterprises’. The bill provides for the creation of the Microfinance Regulatory and Supervisory Authority (MRSA) and a five member Board of Directors (s.5[3]), consisting of an officer of the Ministry of Finance, nominated by the Secretary to the Treasury, an officer of the Central Bank nominated by the Monetary Board and three nominees of the Minister, one an accountant, and two professionals or academics in finance, banking, economics, law, management or any other related field with relevant experience.

The Minister appoints the Chairman from among the Board members who has ‘knowledge in the operation of the financial sector’ (s.5 [5]). Members of the Authority should not be players in a micro finance business licensed with the Authority (3[7]).

The Board will not have any active practitioners of micro finance, it would be useful if some sort of advisory or consultative mechanism, be created by law, since the bill does not provide an institutional basis for the bureaucrats and professionals who are on the Board of the MRSA to consult and get feedback from Micro Finance Institutions (MFI) and practitioners on the ground situation and on things they propose to do.

S.6 provides for the CEO of the Authority to be the Director General who is appointed by the Board. S. 3, provides that the objects of the Authority are, broadly, to license, register, regulate and supervise the micro finance business, to strengthen and develop and qualitatively improve the micro finance business, to ensure its integrity and transparency, to maintain the confidence of stakeholders in the business, and minimise losses by establishing and enforcing standards of accounting, governance and disclosure for the micro finance business.

It is commendable that a developmental object has also been included. The micro finance sector needs some support to expand its human resource capacity and improve monitoring and evaluation.

The database of micro business borrowers also has to be developed, to avoid the charge of over-borrowing – one micro borrower taking loans from multiple micro lenders and way beyond his capacity to repay. With every Sri Lankan having a unique National Identity Card number, this should not be too difficult.

S.11 provides that the following categories of legal persons could apply for a license or registration, in terms of the Bill. A company, in terms of the Companies Act, which is not a private, offshore or overseas one (s.11 {1} a), an NGO registered under the Companies Act, the Voluntary Social Services Act (s.11[1] b), a Co-operative Society, (s.11(1) c.) and a Society, registered under the Societies Ordinance.

There are specific requirements for national level operations (s.11 [2]), provincial and multi district (s.11 [3]), single district and divisional (s.11 [4]).

S.11 (2) explicitly prohibits, a company limited by guarantee, a private company, an offshore company or an overseas company from applying for a license for a national level business. The section also authorises the Board to fix the core capital for company’s which will be granted a license to carry on micro finance business at national level. Commentators have queried why company’s limited by guarantee have been excluded.

This section may not catch up all, entities set up under the various laws, numbering around 38, which apply to micro finance currently on the statute book, and those such as Trusts under the Trusts Ordinance, will have to canvass to be included in terms of an amendment to the draft law, or comply with what the law provides. The pawn broking business is not specifically exempted – does it provide a ‘financial accommodation’?

Exemptions

The following institutions are exempt from the bill: Licensed commercial or licensed specialised banks (s.13 [a]), finance companies (s.13 [b]), Samurdhi banking societies (s.13[c]) and farmers’ organisations (s.13). [d]) set up under the relevant law.

These entities are in direct competition with MFI supervised by the MRSA. They all indulge in the ‘micro finance business’. Is there a legal basis, in terms of fair and acceptable classification for exempting banks, finance companies, Samurdhi and farmer organisations from the MRSA’s supervision and regulation?

It may be unfair discrimination and placing micro finance business subject to the MRSA’s seemingly more rigorously empowered supervision under a disadvantage, due to higher costs of compliance, etc., which may be challenged under the fundamental rights, (equal treatment of same class of persons) jurisdiction of the courts.

Conditions on any investment made by an MFI, minimum ratios, a deposit protection fund, a reserve fund and the power to impose restrictions on MFI activities.S.23 (3) empowers the MRSA to issue a code of corporate governance on licensed and registered MFI.

This part of the Draft Bill will be of critical importance to the future of the micro finance industry. The industry has had access to credit on subsidised terms for two decades from the Credit Fund of the Janasaviya Trust Fund (JTF) and its successor the National Development Trust Fund (NDTF).

The NDTF is to be closed down and the assets transferred to the Sri Lanka Savings Bank, these are repayments made by partner organisations of the Credit Fund, recovered from micro entrepreneurs. The Sri Lanka Savings Bank is supposed to run a dedicated window to finance MFI with these funds.

Part III restricts the type of activities an MFI can undertake and Part IV gives the power to the MRSA to give directions to MFI. Part V deals with financial statements and audit. Part VI provides for examination and supervisory action by the MRSA over MFI.

Part VII is important; the Monetary Board is empowered to set principles or standards to the MRSA, Samurdhi Authority and the Commissioner General of Agrarian Development on micro finance business standards.

Why aren’t the National Commissioner of Cooperative Development and the nine Provincial Commissioners included here? The Cooperative rural banks are a big player in the sector and many other cooperatives such as Sanasa also operate under the Cooperative Laws. Huge amounts of fund are available. It may be advisable to include that regulator too. Again there may be equal protection of law issues to persons within the same class which could attract relief under the fundamental rights jurisdiction of the courts.

Concerns

As I stated earlier, there are over 30 laws presently on the Statute book, which would broadly apply to the ‘acceptance of deposits and providing of financial accommodation in any form’ as the new draft law provides.

Only where low income persons and micro enterprises, as defined by regulation made under the Micro Finance Act, are involved, will the MRSA have authority and the provisions of the draft Micro Finance Act apply.

Where a low income person makes a financial deposit in any financial institution whatever, will the MRSA and the provisions draft act apply? Where a low income person, is given a financial accommodation by, for example a pawn broker, established under the Pawn Brokers Ordinance, will amount to a ‘micro finance business’ as defined in s.10(2) of the draft bill? Will the MRSA and the provisions of the new draft act apply?

There are a number of laws which control financial accommodation. For example, can a borrower from an MFI regulated and licensed by the MRSA claim relief from repaying his debt by going before the Debt Conciliation Board? Can a depositor with an MFI, regulated and licensed by the MRSA, move in terms of the BOI Law, where an MFI has been provided with foreign funds?

Or where he has pledged some valuables and obtained a financial accommodation from an MFI registered and licensed by the MRSA, which is connected to foreign funding source, a foreign share holder, can the borrower claim relief under the Money Lending Ordinance on the basis that a non national cannot engage in the money lending (providing financial accommodation) business in Sri Lanka?

Micro insurance, micro leasing, etc. are financial accommodations which are increasingly becoming popular in Sri Lanka.  How will the Draft Act deal with those concepts, in the context of a pre existing legal regime covering insurance and leasing already in operation?

The draft Act will have to face up to these issues.

A great advance

Notwithstanding these issues, the legislation itself is a great advance. It is a great improvement on the Draft Act which the CBSL presented some time ago. It is certainly an advance on the micro finance sector having to comply with the provisions of 30 or more different statutes which govern various aspects of their operations.

However a consolidation or restatement, either by explicit provision or by reference, to the provisions of these existing 30 plus laws which will apply to micro finance business as defined in the draft would have been useful.

The official attitude in Sri Lanka, to the micro finance sector over time has been one of ‘benign neglect’. (This phase was coined by the late Massachusetts US Senator Pat Moynihan, to describe the Reagan administration’s attitude to coloured Americans). Rarely was anything positive done, but there was no great damage caused to the sector either, by official acts.

On the positive side the Janasaviya Trust Fund’s (JTF) micro credit window brought in over 150 new partner organisations into the MF sector. The National Youth Savings and Credit Cooperative (NYSCO), CBSL’s Isuru pr-oject, the credit window of the Janasaviya Trust Fund and Janasaviya Program and the Samurdhi Project mainstreamed self-help groups and savings mobilisation.

However the JTF, later renamed National Development Trust Fund (NDTF) has now been absorbed into to the Sri Lanka Savings Bank, to function as an apex lender to the MF sector.

Gender empowerment

There is a huge gender empowerment issue with the micro finance sector in Sri Lanka, since over 70% of the loans have been taken by women belonging to the poor and marginalised sectors of society. This should be reflected in the draft, may be by providing for gender equity on the Board of MRSA?

This dynamism and creativity will have to be safeguarded while at the same time having the sector comply with a necessary legal straight jacket. The Preamble to the Draft could also spell out the policy for micro finance in more detail.

The MRSA has a challenging task and could very well be a game-changer in the battle against poverty and marginalisation in Sri Lanka. It is indeed a pity that this bill has not been enacted into law.

In Sri Lanka the Household Income and Expenditure Survey (HIES) of 2009 /10 showed a remarkable decrease in poverty in comparison with previous years. Only 8.9% of households were below the poverty line. The figure in 1995/96 was 28.8%, 2002 – 23.9%, 2006/07 – 15.2%. The outreach of micro finance institutions to poor and marginalised women would surely have affected this alleged improvement.

However these numbers are disputed. The content of the basket of goods, on which the numbers are computed, (needed for a person per day, for a stipulated calorie intake) are not in the public domain. The basket is said to cost Rs. 100 per day, i.e. Rs. 31,000 per month, on average. It has been questioned whether a person can eat even one meal at Rs. 100, let alone survive for a whole day! Further, the malnutrition numbers are at variance with these alleged poverty indicators.

Be that as it may, the current fixation with investment in small and medium enterprises completes misses the target, in that it is reaching out people who are already within the financial system, benefiting from it. Micro finance is the only way to reach those who are marginalised. A policy of ‘benign neglect’ has outlived its time. The MRSA bill, even with all its drawbacks, has to be made law soon, if total financial inclusion in Sri Lanka is to be achieved.

Need of the hour

On 8 December, the fifth Global Micro Credit Summit took place at Valladolid in Spain.

Professor Yunus of Grameen Bank fame, who was recently in Sri Lanka, promoting the concept of a social business enterprise, speaking on that occasion, said: “Micro credit is a way of helping future generations … dark clouds are gathering in the broader economy and they will not go away, they will create frustration and disappointment, a great deal of unemployment and tension in the West. Micro finance by contrast is a shining hope, creating light at the end of the tunnel.”

Shameran Abed, Director of Micro Finance at BRAC of Bangladesh, presenting a paper highlighted the critical role micro finance can play in rural agriculture by providing credit and their networking capacity, which is a trustee conduit to communicate agricultural innovation. This is referred to by practitioners as ‘micro finance plus’.

Speaking in Colombo, Prof. Yunus made the important point that in Grameen it is the savings of the participants which are lent back to them. MFIs cannot operate effectively if they are not permitted by law to take savings deposits.

Recently in Colombo, Prof. Anil K. Gupta, Executive Chair of the National Innovation Foundation of India, delivering the inaugural IESL Ray Wijewardene memorial lecture on ‘Grassroots Innovation for Inclusive Development,’ organised by the Ray Wijewardene Memorial Trust and the IESL, referred to micro venture capital finance being utilised to launch innovators’ ideas as business enterprises. To achieve such heights Sri Lanka needs an enabling, MF-friendly legal regime now.

(The writer is a lawyer, who has over 30 years experience as a CEO in both government and private sectors. He retired from the office of Secretary, Ministry of Finance and currently is the Managing Director of the Sri Lanka Business Development Centre.)