crisis by mldonnet


									                            A comparative analysis of three crisis situations
                NBFC situation of        The Satyam             The Andhra Pradesh and Indian micro-
                    the 1990s           episode of 2009                     finance crisis of 2010
Legal form(s)    The legal entities    Legal entities were         Legal entities are mainly MFIs registered
                 were different        companies engaged           as NBFCs.
                 kinds of deposit-     in providing a range        There are other forms of MFIs including
                 taking NBFCs.         of products and             non-profit and mutual benefit, but the
                                       services.                   large MFIs that dominate the market are
                                                                   mainly NBFCs in terms of their legal
Regulation       By the Reserve        Registrar of                RBI for NBFC MFIs.
and              Bank of India         Companies.                  In addition, SEBI for listed NBFC MFIs.
supervision      (RBI).                For listed companies,       Registrar of societies, trusts and
                 Passive by most       SEBI in the matter of       cooperatives (central and state
                 standards.            market regulation.          governments) for respective legal forms.
                                       Minimal, but for            RBI for banks, including local area banks.
                                       legal compliances           NABARD as supervisor for cooperative
                                       with market                 banks.
                                       regulator.                  Compliance checklist type regulation for
                                                                   NBFC MFIs. No serious asset side
                                                                   supervision for most MFIs.
Growth and        Explosive growth.      Rapid growth to keep       Burgeoning growth, through the years and
competition       Significant            up with competitors.       especially from April 2008 onwards.
                  competition.           Significant                Significant competition in several
                  Special schemes        competition.               pockets–especially urban and peri-urban
                  to woo customers                                  areas.
                  – which asked                                     Several areas became totally saturated and
                  whether customers                                 witnessed intense competition and
                  can spot Rs36                                     multiple and successive lending became
                  lakh in this                                      rampant as a result of this.
                  advertisement and                                 ‘Fastest to disburse’ became the most
                  things like that,                                 important criteria and clients/JLGs were
                  offering abnormal                                 shared between MFIs with different MFIs
                  returns.                                          servicing the same clients/JLGs on
                                                                    successive days!
                                                                    Increasing level of frauds as admitted in
                                                                    the financial statements of MFIs.
Group             Group companies        Group companies            Several entities under an MFI group,
companies         present.               present.                   some of whom are companies, MBTs,
                  Complex                Complex                    trusts–all these tend to be engaged in
                  institutional          institutional              similar or related activities.
                  arrangements.          arrangements.              Tremendous complexity and very difficult
                                                                    to understand the relationships.
                           A comparative analysis of three crisis situations
                NBFC situation of        The Satyam            The Andhra Pradesh and Indian micro-
                   the 1990s           episode of 2009                     finance crisis of 2010
Non-             Funds diverted to    There was                   Possibility of non-transparent transactions
transparent      group companies.     widespread                  between group entities not ruled out.
and related                           speculation of this         There are clear cases of significant related
party                                 funds diversion.            party transactions between group entities
transactions                          A proposal to               and promoters–like loan given by MFI to
                                      facilitate this fund        promoters to buy shares in the MFI and
                                      transfer in fact led to     the like (Professor Sriram’s article in the
                                      the 2009 crisis,            Economic and Political Weekly of June
                                      caused by                   2010).
                                      shareholder activism.
Governance,       NBFC had weak           Despite the various       Despite corporate governance and other
systems, MIS,     governance, poor        corporate governance      awards, many MFIs have weak
etc.              MIS and internal        awards, the company       governance as espoused by the
                  controls and very       and its group had         happenings in recent years, till 2010.
                  little risk             very poor                 MIS is rather nascent and suffers from
                  management.             governance, systems       several weaknesses, too, including lack of
                                          and the like–as it        aggregation across geographies, clients
                                          became clear later.       and products.
                                          First large company       Internal controls and audits are also
                                          to illustrate the fact    nascent and risk management is almost
                                          that a very high          absent.
                                          profile board does        A perfect setting for institutional failure.
                                          not necessarily           One large MFI had an extremely
                                          symbolise or ensure       successful IPO, but the sudden subsequent
                                          good corporate            sacking of the CEO (who led the company
                                          governance.               through the spectacular IPO) raised
                                          It appears that MIS       serious questions about the company’s
                                          (including records)       governance, including board roles,
                                          was fabricated as         compensation, etc. (Article in The
                                          proved by fraudulent      Economic Times, by M Rajshekar, in
                                          financial transactions    October 2010.
                                          undertaken by the         In my opinion, the above illustrations of
                                          company. Controls         not-so-good governance, along with client
                                          also seemed to have       suicides, was among the major triggers of
                                          been manipulated.         the present microfinance crisis.
                                          Self-confession led       Everything else, more or less, follows
                                          the ‘cat’ out of the      from it.
Operational       Ghost plantations       Ghost invoices to         The audit statements of some MFIs point
issues—ghost      and fraudulent          boost operating           to the presence of ghost and non-existent
invoices and      transactions were       results and a whole       clients, misappropriation of client
                             A comparative analysis of three crisis situations
                 NBFC situation of         The Satyam            The Andhra Pradesh and Indian micro-
                    the 1990s            episode of 2009                     finance crisis of 2010
non-existent      a major               range of fraudulent         repayment collections and several other
clients           phenomenon that       and very complex            kinds of frauds, primarily caused by the
                  caused failure.       transactions led to         use of the decentralised agent-based MFI
                                        the collapse of the         model that perhaps uses different kinds of
                                        financial system in         broker agents. The present year’s financial
                                        the companies               statements just confirm the above trends.
                                        concerned and this          It is now apparent that some MFIs
                                        resulted in                 (perhaps even many) have engaged in not-
                                        institutional failure       so-desirable practices like multiple
                                        eventually.                 lending, over lending and even creation of
                                                                    non-existent borrowers (sometimes even
                                                                    to manage delinquency) and so on.
                                                                    This is yet to be examined seriously in
                                                                    terms of a national study, but available
                                                                    evidence provides some support for the
                                                                    above assertions.
                                                                    The regulators and supervisors must order
                                                                    a neutral and objective study of the same.
Operational       The same              Duplicate invoices          Same clients are borrowers of (successive)
issues—           plantations were      had come from same          loans from multiple lenders (multiple and
multiple sales    sold to many          companies.                  sequential lending). There are also ghost
and multiple      investors.                                        clients and other such practices, as
lending                                                             admitted by some of the MFIs themselves.
Use of agents      Agents persuaded        Not applicable            It is now clear from several sources that
                   people to deposit                                 centre leaders and local political leaders
                   money and                                         functioned as MFI agents, pushed loans to
                   disappeared.                                      poor people and used coercive methods
                                                                     and greening techniques to recover the
                                                                     loans from them.
                                                                     Available evidence seems to suggest this,
                                                                     but the RBI would need to look into it
                                                                     carefully in a nationwide manner.
                                                                     The regulators and supervisors must order
                                                                     a neutral and objective study of the same.
Impact of          Loss of deposits        Loss of work              Loans wreaked havoc in the life of the
products/          wreaked havoc on        wreaked havoc on          clients and the enhanced indebtedness is
crisis             clients who lost        hired (regular as well    certainly a very important factor for the
                   their valuable          as surplus)               suicides.
                   savings which is        employees who             The rural and urban low-income credit
                   the first form of       could not even meet       system and economy are in shambles.
                   insurance and           their regular housing
                              A comparative analysis of three crisis situations
                 NBFC situation of         The Satyam             The Andhra Pradesh and Indian micro-
                     the 1990s            episode of 2009                     finance crisis of 2010
                  safety net for the     EMIs.                       Many of the low-income clients may lose
                  rainy day.             Shareholders took a         access to finance in the long term as
                                         beating as the stock        financial institutions may be more
                                         price of Satyam and         reluctant to lend to them, especially in the
                                         related companies           wake of the various problems identified
                                         plummeted.                  during the current crisis.
                                                                     Shareholders of SKS, the only listed MFI,
                                                                     took a beating as the stock price
                                                                     Private equity investors were left without
                                                                     an easy exit strategy and many of them
                                                                     actually suffered huge losses as they had
                                                                     bought SKS shares at a rather high
Target clients    The majority were       A majority of              The majority low-income and financially
                  middle income to       middle-income to            excluded people.
                  economically           economically well-          Vulnerability of the clients and lack of
                  well-off classes.      off classes.                sufficient livelihood opportunities rather
                                                                     huge and a major factor in their getting
                                                                     exploited by the system.
Access to          ‘Cheap’ and             Shareholder funds          By and large, collateral free, soft interest,
capital            unlimited public        and other liabilities.     condition-free (no personal guarantee),
                   deposits and other                                 loans–virtually unlimited scale during the
                   forms of capital.                                  years preceeding the crisis.
                                                                      Priority sector funding is surely soft and
                                                                      privileged money.
                                                                      Also, significant private equity
                                                                      investments into the MFIs, some of whom
                                                                      have used/are using the IPO route to raise
                                                                      huge resources.
                                                                      Some MFIs have had grants from donors
                                                                      which were subsequently capitalised.
Role of            Auditors and            Auditors and others        It needs to be ascertained whether auditors
auditors           others were             were involved in the       and others were involved in some of the
                   involved in the         frauds.                    non-transparent transactions.
                   frauds.                                            This is something that the regulators
                                                                      would need to study carefully.
Issues             No serious              Regulatory arbitrage       No single serious regulator–multiple
concerning         regulator and lack      perhaps resulted in        regulators with different levels of
regulation         of coordination         the collapse of the        supervision and lack of serious
                           A comparative analysis of three crisis situations
               NBFC situation of        The Satyam             The Andhra Pradesh and Indian micro-
                  the 1990s            episode of 2009                     finance crisis of 2010
                among regulators.     company.                    coordination among regulators and
                Clear case of         Clear case of               supervisors.
                regulatory failure    regulatory failure and      The industry appears to be moving
                and no serious        no serious                  towards regulatory arbitrage with the
                supervision.          supervision.                Andhra government stepping in as well.
                                                                  There has been regulatory and supervisory
                                                                  failure and especially for the so-called
                                                                  systemically important NBFC MFIs that
                                                                  were allowed to grow without any sort of
                                                                  checks and balances.
Consequences     NBFCs failed,          The Satyam fiasco         The image of microfinance has taken a
and future       loss of money for      dented corporate          severe beating.
aspects          depositors, and        India like no other       MFIs are no longer considered the
                 significant loss of    event and we are still    torchbearers of development and poverty
                 faith in the NBFC      recovering from the       reduction.
                 system within          financial and image       Not sure of where the future is headed,
                 civil society.         loss suffered.            although I hope we will be able to achieve
                 More stringent                                   balanced enabling regulation and
                 regulation/supervi                               appropriate supervision that provides
                 sion of NBFCs.                                   legitimacy, ensures certain minimum
                                                                  operational (including governance)
                                                                  standards and necessary systems for MFIs
                                                                  and also protects clients.

To top