On this page we have uploaded the Gauhati University Micro-finance B.COM 4th Semester, Unit 5 "Legal And Regulatory Framework For Microfinance" Notes, Which can Be Useful for B.com Final Exams.
Also useful for Dibrugarh University, Rabindranath Tagore University, Hojai B.Com 4th Sem Students.
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UNIT-5
LEGAL AND REGULATORY FRAMEWORK FOR MICRO FINANCE
Short Question Answer
1. What are Microfinance Institutions?
Ans: Microfinance Institutions, as the name suggests, it plans to cater to the financial need of the smallest strata (low-income group) of the society. The smallest category of the society like rural women, peasants, workers and other such small people who have no capacity to visit the banks for loan application in connection with their occupations. The microfinance industry has achieved an unprecedented growth over the last two decades Therefore Microfinance Services Regulation Bill has been introduced for the purpose of financial assistance to be provided to an eligible individual directly or by a group mechanism for certain purpose to be achieved by the borrowers(members).
2. Give two challenges faced by the Indian microfinance industry?
Ans: (i) High rates of interest being charged to members, (ii) Over-dependence on the banking system to procure the funds for MFI business.
3. Define SEWA Bank.
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4. Define Grameen Bank?
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5. Mention two Important Characteristics of Microfinance?
Ans: Important Characteristics of Microfinance :
• Microfinance is a means for the empowerment of poor women
• Loans under microfinance programmes are very small.
6. Mention two Key Principles of Microfinance?
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7. Define Delivery Models of Microfinance?
Ans: India has acceptable large number of models of Microfinance, each of which has become hugely popular. India hosts the maximum number of Microfinance models, both in indigenous practices as well as in modern Microfinance. The models range from pure "home-spun" varieties like the SHGs and the co-operatives to the "adapted" models like the Grameen methodology and the for-profit corporate models. In the active field of microfinance, there is clearly no one best way to deliver services to the poor - multiple models exist and each has succeeded in their respective contexts. There could be many more alternative technologies that have been successful in providing micro-finance services to the poor. It can be seen that the desire to make micro-finance an industry, commercialize microlending and enable MFIs to become profit making institutions should not divert institutions from one major and integral aspect of micro-finance - i.e., social intermediation. Preparing the borrower (both groups and individuals) has been the distinctive competence with which, many Indian MFIs have achieved success. And this takes time and effort, which a target oriented micro-finance sector cannot provide.
8. Define Society Registration Act, 1860?
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9. Mention two Advantages for MFIs of Registration under the Societies Act?
Ans: Advantages:
(a) Simple process of registration.
(b) Simple record keeping and even simpler regulations.
10. Mention two Disadvantages for MFIs of Registration under the Societies Act?
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11. Define Indian Trust Act, 1882 ?
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12. Mention two Advantages and Disadvantages of registration under the Indian Trusts Act?
Ans : Advantages:
(a) Simple process of registration.
(b) Simple record-keeping and even simpler regulations.
Disadvantages
(a) As charitable institutional form, is inappropriate for the for- profit, financially sustainable strategic goal of microfinance operations therefore the tax-exemption for surpluses can be challenged on the question of whether provision of microfinance services is a charitable activity.
(b) There no system of equity investment or ownership which is making it less attractive for commercial investors interested in microfinance.
13. Define Non Banking Finance Companies (NBFCs) ?
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14. Mention two two essential pre-requisite for carrying on the business of an NBFC?
Ans: (a) Obtaining a certificate of registration from RBI.
(b) Having Net Owned Funds (NOF) - shareholder equity + internally-generated reserves of Rs 200 lakh. This limit was earlier Rs 25 lakh only, it has now been increased to Rs 200 lakh by RBI. Vide notification no DNBS 132/CGM (VSNM)-99, dated 20-4-1999,the RBI specifies the "net-owned fund" (NOF) to be Rs 200 lakh, for an NBFC which commences the business of an NBFC after April 21, 1999. Thus, this specification of higher "(NOF)" is not applicable to NBFCs that commenced business before April 21, 1999.
15. Give two Advantages and Disadvantages of NBFCs ?
Ans: (a) The minimum capital requirement (Rs 2 crore) for obtaining a license for an NBFC is high. Given the nature of microfinance in India, and the relatively small size of most MFIs, the mobilization of funds of this volume becomes a major challenge. This is further complicated as the promoters of such NBFCs are largely societies that are not allowed to make equity investments, lest they lose their tax exemption status.
(b) NBFCs are not allowed to mobilize deposits unless they complete two years of operations and then obtain an investment grade rating. Such a rating is doubly difficult to get for MFIs - even those with strong portfolios - since the conventional credit rating agencies designated for this purpose by the RBI regard lending to the poor and lending in rural areas as 'inherently risky'.
16. Define Nidhi Companies ?
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Long Question Answer
1. Discuss the evolution of Indian Microfinance sector?
Ans: The evolution of Indian Microfinance sector can be broadly divided into four distinct phases:
(a) Phase 1: Subsidized Social Banking (1960 - 1990): In 1960, India made one of the largest interventions in rural credit market and it was referred to as social banking phase. The government focused on measures such as nationalization of commercial banks, expansion of rural branch networks, establishment of Regional Rural Banks (RRBs) and Lead Bank Scheme was initiated with district credit plans. Apex institutions were set up such as the National Bank for Agriculture and Rural Development (NABARD) and the Small Scale Industries Development Bank of India (SIDBI), including initiation of a government sponsored Integrated Rural Development Programme (IRDP) for extensive disbursement of subsidized credits. Though during this period the sector had cater the need of large population, the given period is characterized by misuse of credit at large scale, negative perception about the credibility of micro borrowers among bankers etc. This led to restricting the access of banking services for the low income people.
(b) Phase 2: SHG-Bank linkage program and growth of NGO-MFIs (1990-2000): The failure of subsidized social banking triggered a paradigm shift in delivery of rural credit with NABARD initiating the Self Help Group (SHG) Bank Linkage Programme (SBLP), aiming to link informal women's groups to formal banks. In SHGs movement, poor household from rural India are organized homogeneous groups of 10 -20 each, and pulled their money which was lent to the needy in the group in form of credits. The program helped to increase banking system outreach to otherwise unreached people and initiate a change in the bank's outlook towards low-income families from 'beneficiaries' to 'customers'. The above mentioned programmes were initiated and rapidly replicated. This period was thus marked by the extension of credit at market rates. The model generated a lot of interest among newly emerging Microfinance Institutions (MFIs), largely of nonprofit origin, to collaborate with NABARD under this program. The macroeconomic crisis in the early 1990s that led to introduction of the Economic Reforms of 1991 resulted in greater autonomy to the financial sector. This also led to emergence of new generation private sector banks that would become important players in the microfinance sector a decade later. In short, innovative credit lending mechanisms based on "peer pressure" and "moral collateral" were developed. According to NABARD report 2013, the number of savings linked SHGs increased to about 7.96 million with the member base of 104 million.
(c) Phase 3: Financial Inclusion (2000 onwards): Post reforms, rural markets emerged as the new growth drivers for MFIs and banks, the later taking interest in the sector not only as part of their corporate social responsibility but also as a new business line. Microfinance is seen as business proposition and has been commercialized. On the demand side, NGO-MFIs increasingly began transforming themselves into more regulated legal entities such as Non Banking Finance Companies (NBFCs) to attract commercial investment. In other words, NGO-MFIs are being legitimized. The microfinance sector as it exists today essentially consists of two predominant delivery models the SBLP and MFIs. According to Status of Microfinance report 2012-13, SBLP crossed many milestones, from linking a pilot of 500 SHGs of rural poor of two decades ago to more than 8 million groups a year ago. On the other hand, the MFIs reported a total client base of 23.4 million. Further, the total savings corpus has increased from few thousands of Indian Rupees in the early years to a whopping 27,000 crore today, bank credit to a credit outstanding increased to 40,000 crore and disbursements touching 20,000 crore during 2012-13 (NABARD, 2013).
2. Explain the Important Characteristics of Microfinance?
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3. Explain the Status of Indian MFIs?
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4. Explain the qualifying asset norms laid by RBI?
Ans: Following are the qualifying asset norms laid by RBI :
(a) Loan must be to rural household with annual income of not more than INR 60,000. In case of urban or semi-urban borrower, household income must be INR 120,000 or less.
(b) Loan amount cannot exceed INR 35,000 in first cycle and INR 50,000 in subsequent cycles.
(c) A household's total indebtedness at any given time should not exceed INR 50,000
(d) Loan term should not be less than 24 months for amounts more than INR 15,000 without prepayment penalty.
(e) Loans to be extended without collateral.
(f) Aggregate amount of loan for income generating purposes must be at least 75% of total
advances.
(g) Loans must be repayable by weekly, fortnightly or monthly installments, the choice of which will vest with the borrower.
5. Explain five Key Principles of Microfinance?
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6. Explain the Society Registration Act, 1860? Explain the advantages and disadvantages of Society Registration Act, 1860?
Ans: The Societies Registration Act 1860 states that "a society can be formed for the promotion of literature, science or the fine arts or the diffusion of useful knowledge/political education or for charitable purposes." Once the name of the proposed society and also the draft memorandum and rules and regulations of the society have been decided, the procedure for the registration of the society can be taken up. Normally a fee of Rs 50 is payable as registration fee of society and it should accompany the request for registration payable in cash or by demand draft. Formalities for registration and requirement of the documents may differ a bit from state to state. The applicant had to contact to the Registrar of the Society in advance. Members of the governing body of a society are the trustees of the property of the organization. Therefore, the management of the assets and liabilities of the organization is the responsibility of the governing body members. Many provisions in the Principal Act provide the manner in which the society is required to function and for all purposes it is the governing body that is responsible for the conduct of the society. To keep an independent check on the accounts maintained by the societies, various provisions have been made by state governments for auditing of their accounts. The Registrar of Societies in each state enforces the provisions of the Principal Act or the corresponding Acts enacted by the other states. The powers and duties of the Registrar are to:
(a) Certify and inspect documents;
(b) Call for documents;
(c) Enquire into and settle disputes;
loan. MFIs understand the return on investment, repayment capacity and risk bearing ability of the clients for the production loans. At the same time, while mobilizing saving, it's the client who trust the MFIs for their saving. Clients need MFI for saving that trustworthy, stable and at the same time client should be assured that their savings are secure.
(b) Microfinance is not only development but also an integrated part of financial sector in India: In India, microfinance is considered as a concern of donors, charity organizations, and government development programmes. But microfinance programme meets the financial needs of people supplementing in the financial system.
(c) Financial sustainability of MFIs depends upon delivery mechanism: Financial sustainability of
microfinance depends upon the level of outreach of the products and services. The cliental base and outreach of the MFIs depends upon their disbursement capacity and delivery mechanism. More and more people can access the microfinance products if the MFIs have strong delivery mechanism.
(d) Microfinance develops local financial institutions : Microfinance is based on the local level intervention of saving mobilization of savings, extension of credit, provision of insurance and provision of payment transfer and other products. These products and services can efficiently and effectively delivered by creation of local institutions. Local NGOs can act as intermediary between clients and microfinance wholesalers like banks and insurance companies. At the same time, the intermediaries develop the local level institutions like groups, federations, etc. for disbursal of microfinance products. Sustainable microfinance can be ensured by development and effective performance of these local institutions.
(e) Microfinance is not microcredit but variety of products: Most of people have wrong assumption that microfinance is nothing but microcredit and microdot is appropriate tool for societal upliftment and poverty alleviation. But only microcredit cannot bring a positive change in the socio-economic status unless microcredit is provided along with saving, insurance, money transfer etc. thus microcredit coupled with other financial and non financial products will serve as a package for development.
Advantages:
(a) Simple process of registration.
(b) Simple record keeping and even simpler regulations.
(c) Low possibility of interference by the regulator.
(d) Exemption from tax due to the overtly charitable nature of berations
Disadvantages:
(a) As a charitable institutional form, in essence inappropriate to the for-profit, financially sustainable strategic goal of microfinance operations.
(b) Tax-exemption for surpluses can be challenged on the question of whether provision of microfinance services is a charitable activity.
(c) No system of equity investment or ownership, thereby, making it less attractive for commercial investors interested in microfinance.
(d) Commercial investors generally regard the investments in such entities risky. primarily on account of their lack of professionalism and managerial practices and are, therefore, reluctant to commit large volumes of funds to such MFIs.
7. Explain the Indian Trust Act, 1882? Explain the advantages and disadvanatges of Indian Trust Act, 1882?
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8. Explain Non Banking Finance Companies (NBFCs) ?
Explain the advantages and disadvantages of Non Banking Finance Companies (NBFCs)?
Ans: In fulfilling the gap between demand and supply of financial services, Non banking Financial Institutions have played an important role in Indian Financial Sector. It is the higher interest level of customer, lower documentation requirement and higher interest rates for the borrowers had promoted the growth of NBFCs. Conversely, depositors earn substantially higher rates of interest as compared to the traditional savings instruments of banks. In this way, NBFCs are able to attract a large volume of deposits from the general public. Lower entry barriers and high returns (in relation to banks) from the NBFC business attract lots of entrepreneurs. Many such companies have been unable to service their debt obligations due to ineffective asset-liability matching and spectacular collapses, like CRB Caps in Ahmedabad and Century Consultants in Lucknow, which has resulted in considerable loss of public confidence in NBFCs' services. Recognizing the importance of NBFCs in the Indian financial sector RBI started to regulate them from 1996 to bring them into main stream. These measures include mandatory registration of companies offering financial services with the RBI, compulsory credit rating of deposit taking NBFCs and imposition of prudential norms. As per the Section 45-1 of the RBI Act, an NBFC is a company which carries on any (c) The entire financial sector is denied access to venture capital investment and was denied access to external commercial borrowings (ECB) until very recently. Since there are venture capitalists - foreign or domestic - willing to put their money into microfinance, any restriction of this sort places an additional handicap for MFIs. Yet, there are an increasing number of socially responsible international investment funds for micro- finance and their investments are effectively barred from India.
(d) Foreign direct investment (FDI) in equity is allowed but must be for a minimum of $0.5 million (Rs 2.15 crore today) and cannot exceed 50 per cent of the equity of an NBFC. This means that the MFI must first raise more than Rs 2.2 crore from domestic sources before it can become eligible for foreign equity investment.
9. Explain Nidhi Companies? Explain the Advantages and disadvantages of Nidhi Companies?
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10. Explain The legal framework for MFIs in India with reference to its registration and other parameters ?
Ans: The legal framework for MFIs in India with reference to its registration and other
parameters can be broadly narrated as under:
(a) For Societies: Registration for this is a very easy process with no minimum capital requirement. Further, they are not allowed for deposit mobilization/collection from the public. It has to operate amongst its members only.
(b) For Trust: Registration for this is very easy with no minimum capital requirement. It is not allowed for deposit mobilization/collection from the public. It is sometimes problematic as the funds for further expansion may not be available. It has limited scope for expansion.
(c) For Sec. 25 Companies-Registration is easy but not that easy as those of trusts and societies, especially for an existing company to convert into a Section 25 company. It is not allowed for deposit mobilization/collection from the public. However, it contributes a lot to the process of financial inclusion.
(d) For NBFC-MFI: Registration for this is to be taken up with RBI and it is difficult to obtain due to stringent provisions of the RBI. It requires minimum capital of Rs. 5 crores (Rs. 2 crores for North-East India region) to start MFI operations. It is not allowed for (B) Votes of members
(i) Where the liability of the members of a registered society is not limited by shares, each member shall, notwithstanding the amount of his interest in the capital, have one vote only as a member in the affairs of the society.
(ii) Where the liability of the members of a registered society is limited by shares, each member shall have as many votes as may be prescribed by the by-laws.
(iii) A registered society which has invested any part of its funds in the shares of any other registered society may appoint as its proxy, for the purpose of voting in the affairs of such other registered society, any one of its members.
(C) Restrictions on transfer of share or interest
(i) The transfer or charge of the share or interest of a member in the capital of a registered society shall be subject to such conditions as to maximum holding as may be prescribed by this Act or by the rules.
(ii) In case of a society registered with unlimited liability a member shall not transfer any share held by him or his interest in the capital of the society or any part thereof unless :
(1) he has held such share or interest for not less than one year, and
(II) the transfer or charge is made to the society or to a member of the society.
13. Explain the Duties of a Registered Society?
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14. Explain the Rules of a Cooperative Society Act?
Ans: (a) The State Government may, for the whole or any part of the State and for any registered society or class of such societies, make rules2 to carry out the purposes of this Act.
(b) In particular and without prejudice to the generality of the foregoing power, such rules may
(i) subject to the provisions of section 5, prescribe the maximum number of shares or portion of the capital of a society which may be held by a member;
(ii) prescribe the forms to be used and the conditions to be complied with in the making of applications for the registration of a society and the procedure in the matter of such applications;
(iii) prescribe the matters in respect of which a society may or shall make by-laws and for the procedure to be followed in making, State Government may, be special order in each case and subject to such conditions, if any, as it may impose, exempt any society from any of the requirements of this Act as to registration.
(C) Power to exempt registered societies from provisions of the Act: The State Government
may, by general or special order, exempt any registered society from any of the provisions of this Act or may direct that such provisions shall apply to such society with such modifications as ma be specified in the order.
(D) Prohibition of the use of the word "co-operative": (i) No person other than a registered society shall trade or carry on business under any name or title of which the word "co-operative" is part without the sanction of the State Government: Provided that nothing in this section shall apply to the use by any person or his successor in interest of any name or title under which he traded or carried on business at the date on which this Act comes into operation. (ii) Whoever contravenes the provisions of this section shall be punishable with fine which may extend to fifty rupees, and in the case of a continuing offence with further fine of five rupees for each day on which the offence is continued after conviction there for.
(E) Indian Companies Act, 1882, not to apply : The provisions of the Indian Companies Act, 18821 (6 of 1882), shall not apply to registered societies.
(F) Saving of existing societies: Every society now existing which has been registered under the Co-operative Credit Societies Act, 1904 (10 of 1904), shall be deemed to be registered under this Act, and its by-laws shall, so far as the same are not inconsistent with the express provisions of this Act, continue in force until altered or rescinded.
15. Explain the features of the Micro Finance Institutions Bill 2012?
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Very Long Question Answer
1. Explain briefly the Key Principles of Microfinance ?
Ans: (a) MFI trust for credit and clients trust MFI for savings: While loan disbursement, the MFIs trust clients for the repayment of the loan, MFIs understand the return on investment, repayment capacity and risk bearing ability of the clients for the production loans. At the same time, while mobilizing saving, it's the client who trust the MFIs for their saving. Clients need MFI for saving that trustworthy, stable and at the same time client should be assured that their savings are secure.
(b) Microfinance is not only development but also an integrated part of financial sector in India: In India, microfinance is considered as a concern of donors, charity organizations, and government development programmes. But microfinance programme meets the financial needs of people supplementing in the financial system.
(h) Saving is not only a source of fund but also a liability for MFIs: The general assumption is that the saving from clients is the source of funds for the MFI in provision of loan (as perceived in general banking theory). The saving mobilization by MFIs from clients is prone to various risk factors like internal fraud, loan defaults and other security measures.
(i) Provision of few well structured microfinance products than the provision of too many structured microfinance products: MFIs should avoid providing too many customized products and should rather focus on few well structured products which can target maximum number of clients. Providing too many structured products may create complexity and confusion in the operation of MFIs.
(j) Saving should be mobilized not only from the poor but also from public: For long term sustainability, MFIs should not focus on the poor for mobilize savings rather they should focus on general public along with the poor. This will help MFIs to address many small savers. The cost of mobilizing saving from poor is very high and expensive for the MFIs and it can be compensated or subsidized from profit earned from saving mobilization from public. The cross subsidization will help the MFI to maintain its sustainability and validity for the long term operations to address large number of poor savers.
2. Explain the Delivery Models of Microfinance?
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3. Explain the Legal Structure of MFIs ?
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4. What is microfinance regulation and supervision? Should microfinance be regulated?
Ans: "Regulation" refers to the set of government rules that apply to microfinance. Supervision is the process of enforcing compliance with those rules. Microfinance providers that take deposits need "prudential" regulation. This type of regulation protects their financial soundness to prevent them from losing small depositors' money and damaging confidence in the financial system. Prudentia I regulation- which mandates, for instance, capital-adequacy requirements and rules for provisioning loan losses is relatively difficult, intrusive, and expensive because it involves understanding and protecting the core health of an institution. "Non-prudential" rules-e.g., screening out unsuitable owners/managers or requiring transparent reporting and disclosure-of US$500,000 applies, also with a cap of no more than 51 percent stake in the institution. Grants and subsidised onward-lending funds from domestic and foreign sources are not restricted, provided that the foreign grants do not exceed the ceiling of US$5mn per year.
(c) Money Lending Act: The Indian Moneylenders' Act 1918 has been adapted by various state governments to restrict interest rates charged by moneylenders. Although the primary purpose of this act is to protect the vulnerable section from usurious interest rates that moneylenders charge, some states have applied the act to Societies and Trusts also to restrict their lending activity. Other states have applied the Money Lending Act to other forms of MFIs.
(d) State Level Regulation : In late 2010, the Andhra Pradesh government enacted the AndhraPradesh Micro Finance Institutions (regulation of money lending) Ordinance, which was later enacted in to Act, to regulate the activities of MFIs. The Act stops MFIs from collecting old loans and originating new loans until the institution registers with the district authorities where they operate. The Act also mandates an interest rate cap such that the total interest charge cannot exceed the principal amount of the loan. The Act also entrusts a great deal of discretionary power to the registering authorities and imposes restrictions on collection practices.
Regulation by the RBI and Money Lenders Legislations: Microfinance entities have approached the courts to resolve the issue of 'dual regulation3' by the RBI and under the State Level Money Lenders Legislations. These microfinance entities contend that an NBFC engaged in microfinance operations, if it has registered itself under RBI norms, should be exempt from registration under the state money-lending norms. This is because certain aspects pertaining to the functioning of the NBFCs such as procuring a licence, the regulation of 'levy of interest' and rate of levy of interest would be subject to dual regulation if exemption from state-money-lending legislations is denied. State-wise, there are two questions which have to be answered to predict whether the issue of conflict between a State Money Lenders Act, and the RBI norms will be resolved in the same fashion: the issue of dual regulation, and specifically, whether RBI. Norms (such tend to be easier to administer because government authorities do not have to take responsibility for the financial soundness of the organization. Microfinance needs different treatment than normal banking primarily because microfinance assets consist of many small, uncollateralized (that is, unguaranteed) loans. Areas of regulation that typically require adjustment include unsecured lending limits, capital-adequacy ratios, rules for provisioning loan-losses, and minimum capital requirements. The following considerations should guide decisions about whether to regulate microfinance:
• Credit-only MFIs: Prudential regulation is needed only when there are depositors to protect, so it is not appropriate for credit- only MFIs that fund themselves from donors or commercial loans. Such MFIs may require relatively light non-prudential regulation.
• Small community: based organizations. Some community- based deposit-taking organizations are so small or remote that effective prudential supervision would be too expensive. Unsupervised deposit- taking institutions are risky. But other options that clients use for savings (cash, livestock, etc.) may be even riskier, so that shutting down such organizations may not improve depositor safety. Most regulators facing the question have decided to let these small intermediaries operate without prudential regulation and supervision, as long as their assets and number of clients remain below defined size limits.
• Country conditions: To take deposits safely, MFIs have to be profitable enough to cover their costs, including the financial and administrative costs of the deposits they collect. Otherwise, losses will eventually erode depositors' money. It may make sense to wait until a critical mass of MFIs meets this qualification before setting up a licensing regime for microfinance. In countries that have implemented microfinance regulation smoothly and effectively, the regulation has tended to follow rather than lead the development of the industry.
5. Explain the Challenges faced by Microfinance Institutions?
Ans: The concept of microfinance was introduced in the Indian economy with the primary objective of financial inclusion of more impoverished and backward sections, especially the women. The growth trajectory of the Indian microfinance industry has been phenomenal since the time it was introduced. Factors like the support of the National Bank for Agriculture and Rural Development (NABARD), linkage of the banking system with the self-help groups have further steered the underserved sectors of the Indian economy towards success through microfinance. However, when it comes down to comparing the plush success of commercial banks, it is only fair to conclude that microfinance institutions have a long way to go. Not only do microfinance institutions lag in structural and operational approach, but also in overall financial processes.
Here are Challenges faced by Microfinance Institutions :
(a) Over-Indebtedness: The microfinance sector deals with marginalized sections of Indian society intending to improve their standard of living, and thus over-indebtedness poses a severe challenge to its growth. The growing trend of multiple borrowing by clients and inefficient risk management are the most significant factors that stress concepts. There is a severe lack of awareness of financial services provided by the microfinance industry among the masses. This lack of adequate knowledge is a significant factor that keeps the rural population from accessing MFIs for easy credit to meet their financial needs. It also contributes to widespread financial exclusion in the country. The additional task of educating masses and establishing trust before they initiate loans also falls on the shoulders of MFIs. The severe lack of awareness about policies and products offered by MFIs make it difficult for these institutions to sustain in excessively competitive environments that developing nations are home to.
(f) Regulatory Issues: The Reserve Bank of India (RBI) is the premier regulatory body for the microfinance industry in India. However, RBI more or less caters to commercial and traditional banks more than it helps MFIs. Even the needs and the structure of microfinance institutions are entirely different from those of other conventional lending institutions. Some regulations seem to have benefitted the MFIs, but others left numerous issues unaddressed. In spite of sporadic and unprecedented regulatory changes, the Microfinance industry appears to have been struggling to sustain. While new regulations result in structural and operational changes, they also result in ambiguity in norms of conduct. The result is sub- optimal performance and failure in the development of new financial products and services. Conclusively, there is a need for a separate regulatory authority for the microfinance industry.
(g) Choice of Appropriate Model: Most Indian MFIs follow the Self-Help Group model (SHG model) or the Joint Liability Group model (JLG model) of lending. They hardly select the model based on scientific reasoning. Most MFIs choose the models randomly, regardless of the situation. What's more, is that the choice of the model increases the risk of borrowings for the weaker section beyond they can bear and is irreversible. In the end, the decision of the model affects the sustainability of the MFI organization in the long-run.
6. Explain the Problems Faced by Debt Collection Agents?
Ans: (a) Oral Contracts: Oral contracts are entered into verbally, without any written record of the same. This means that if the the microfinance industry in India. The microfinance sector gives loans without collateral, which increases the risk of bad debts. Fast-paced growth needs proper infrastructural planning, in which the Indian microfinance sector evidently lacks.
(b) Higher Interest Rates in Comparison to Mainstream Banks: The financial success of MFIs is limited when compared to commercial banks in India. The centuries-old banking system has a strong foothold in Indian grounds and is slowly evolving to meet the needs of the times. Most Microfinance Institutions charge a very high rate of interest (12-30%) when compared to commercial banks (8- 12%). The regulatory authority RBI issued guidelines to remove the upper limit of 26% interest on MFI loans. While many MFI sector players benefited from the RBI guideline update, the borrowers were left for the worse. A massive trend of farmer suicide in states like Andhra Pradesh and Maharasthra is the outcome of borrower indebtedness that resulted from the higher interest rates.
(c) Widespread Dependence on Indian Banking System : Because most microfinance institutions function as registered Non- Governmental Organizations (NGOs), they are dependent on financial institutions such as commercial banks for stabilized funding to carry out their own lending activities. Most of these commercial banks are private institutions charging a higher rate of interest. They also sanction loans for shorter periods. The massive dependence of Indian MFIs on banks makes them incompetent as a lending partner.
(d) Inadequate Investment Validation : Investment valuation is a crucial capability for the healthy functioning of an MFI. The developing nature of the markets in which MFIs operate, the market activity is often limited. That is why it becomes difficult for MFI to gain access to market data for valuation purposes. Lack of consistent and reliable valuation procedures, MFI management teams, are unable to achieve the level of quality information that they need to be able to make investment decisions.
(e) Lack of Enough Awareness of Financial Services in the Economy: A developing country in the making, India has a low literacy rate, which is still more moderate in its rural areas. A large chunk of the Indian population fails to understand the basic financial terms of the contract are not met, both the parties have no paper trail to follow and prove that such a contract was even entered into, which will render the aggrieved party helpless as they will not be able to challenge it in the court of law. Therefore, oral contracts should be avoided as far as possible by the businesses. But if there are instances where oral contracts are the generally accepted trade practice, she same should be done in the presence of witnesses, who can at the very least attest the existence of such a contract in the event of a breach.
(b) Faulty Written Agreements: Written agreements are no better than oral contracts, wherein the existence of the contract can definitely be proved easily, but it comes with another set of problems altogether. Apart from being poorly drafted, the parties involved in many written agreements are not habituated to get a grip of the undersigned terms and conditions of the contract. A lot of times people end up entering into a contract which was null and void from the very beginning, but had no knowledge of the same since they did not bother asking relevant and meaningful questions at the start, which ultimately leads to cancellation of the contract and the lending party is sad, left nowhere to go. Therefore, before entering into any written agreement an important prerequisite to pay attention to is to ask questions if something sounds fishy or looks vague.
(c) Money Recovery Issues: Some of the most basic problems with regards to recovery of debts are the terms and conditions of the contract entered into, how valid are they? What is a certainty? What is the financial background of the parties entering into the contract?
(d) Collection Methods Are Not Real-Time : One of the major roadblocks in the process of debt recovery is the absence of real-time collaboration between the borrower and the collector. This is a huge industry- wide challenge faced by all collection agents. Every debtor's repayment abilities are unique owing to differences in their financial backgrounds, which requires collectors to create customised collection plans. But due to frequent communication breakdowns, this is made very difficult. All of this not only results in a long, complicated and incomplete collection process but also hinders them from offering smooth customer experience.
7. Explain How to Solve Problems Faced by Debt Collection Agents?
Ans: In order to solve the pain points of the collection industry, taking assistance from the modern collection systems and processes is inevitable. The modern collection processes aim to streamline operations and lead to a win-win situation for both debtors and creditors. A modern collection management software comes handy, letting the collection agents take advantage of the robust internet networks and a centralized financial system :
(a) Auto-generated Customer Statements: Your debtors should be able to receive all his customer statements and payment notifications via SMS and emails, which is mostly available at everyone's quick disposal. This should also include a UPI payment option where customers are given the convenience to make online payments using their debit or credit cards, thus avoiding the wastage of time in taking a trip to the bank.
(b) Digitized Strategies: One of the major benefits of going digital via software is to be able to segregate and segment your customers. Debtors should be segmented based on factors such as amount due, ageing, percentage outstanding and credit limit. The software will use as data like if they currently have debts with other creditors, are they repaying them timely etc. Also, it is important to obtain the correct customer identification information like phone number, current employer, contact information, copy of permitted identity proof etc. Having this handy will help them carry out debt recovery process effectively and reach out to references in case the debtor turns delinquent or has disappeared completely.
(h) Get Clarity: The agents should be clear with regards to the rights and obligations of the debtors and the creditors right from the beginning. Get information about any documented terms of credit, credit applications or invoices. This will help them to set the recovery process straightforward from beginning to end also ensure that the stance of the creditor is strong to demand payment, in tandem with the terms agreed upon.
(i) Multiple Payment options: Help your debtors to make the payments as seamlessly as possible. Offer them a wide array of payment options such as credit cards, debit cards, corporate purchasing cards etc. This helps the customer save time and resources as they don't have to deal with physical paperwork and offers the convenience to make payments from the comfort of their home through a secure network connection.
(j) Use Artificial Intelligence: Technology has transformed every sector and debt collection industry should also leverage its benefits. Modern conversation tools available today such as Artificial Intelligence, chatbots and self-service technology has provided the much-needed makeover to the collection process. This technology helps lenders to reach out to people via channels that are more conducive to a conversation. Agents have better chances to negotiate the debt recovery via such friendly channels as opposed to threatening phone calls and result in higher repayments. The collection industry as a whole is in dire need of innovations to recover bad loans and improve the inefficiencies in the system. The above steps will help debt collection agents to deal with debt recovery in a better manner, streamline operations as well as adopt a customer-centric approach to the whole process.
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