Regulating micro-credit | Daily News


 

Regulating micro-credit

Tactics by microfinance providers cause outrage

Problems of over indebtedness, predatory lending and unethical recovery tactics by microfinance providers have caused outrage among activists who stumbled on these practices.

In parts of the north and east, some women keep track of their microloans by the day of the week the collectors come. Others identify the lenders by the colours of their collectors’ shirts. Monday loan, Tuesday loan, blue shirt, yellow shirt.  The Economist reported a central-bank official as saying his employees have talked desperate borrowers out of killing themselves. At least 170 committed suicide last year.

A suicide by a victim last year caused an outcry that prompted the government to intervene, capping interest rates and announcing a moratorium on repayment for some loans. The intervention by the government was ad-hoc and its effectiveness is uncertain.

However, the problems of the industry are real so there is a need for comprehensive regulation of the sector. The proposed new Credit Regulatory Act goes some way to addressing this need.

The biggest problem with existing regulations is that it contains a loophole that allows unregulated operators to flourish. There are two categories of microfinance providers; the formal ones, regulated by the Central Bank (CBSL) who are members of the Lanka Microfinance Practitioner’ Association (LMPA) and informal ones.

The regulated businesses must follow Central Bank rules and have also adopted a code of conduct that addresses some of the problems. The issue is that existing regulations are framed more from a prudential perspective (i.e. to ensure depositors don’t lose money) and are thus restricted to those who accept deposits. Micro lenders who do not accept public deposits (using other sources such as bank loans or their own capital) do not fall within the rules.

This gap allows unregulated businesses to function. The high interest rates charged from borrowers means that even if these businesses raise funds through bank overdrafts they can still lend profitably. These unregulated businesses are not obliged to follow any codes of practice and are blamed for the worst excesses. The latest development is the emergence of online providers who are also outside the regulatory net.

For a start the CBSL regulations must be framed from the perspective of consumer protection and broadened to cover all lending businesses. The new Credit Regulatory Act proposed by the government seems to cover this loophole. Assuming it is enacted it will bring every provider under the supervision of the CBSL, but whether the regulator has adequate enforcement capacity is a question.

The regulated industry follows a voluntary code of practice and although it covers a few key areas it is not comprehensive. The main weaknesses in the current code include:

1. The philosophy of the code must centre on the duty to protect the public.This includes protecting the interests and respecting the dignity of clients at all times. They should have a duty to provide professional advice, placing the client’s interests above their own.

2. A cooling off period – a period of (say) three working days. A client is allowed to repay the loan in full within the cooling off period with all charges waived (with the exception of interest charged at bank prime rate for the period over which the advance was outstanding).

3. Clients shall be entitled to early loan repayment without penalty.

4. Must spell out unacceptable recovery practices in more detail (eg cannot contact clients at odd hours or inappropriate moments such as sickness, bereavement)

5. The incentive structure for staff should promote good business practices (collection targets, collection incentives, lending incentives can drive malpractices. There needs to be ongoing review of these).

6. The boards of the lenders should have 1/3 independent directors and comply with the governance codes issued by the CSE and SEC, even if not listed.

The code need not be made law but should be endorsed by the regulator and its adoption made compulsory. The code must be made available to all borrowers at the time a loan is granted. The current code sets lending limits (to prevent over-indebtedness) but to make this work the CBSL must set up a central database of loans that all providers should have access to. Lenders need to check the quantum of existing loans before any new loan can be offered.

An industry ombudsman and internal complaints mechanism must also be a part of the regulations. All businesses should have a hotline to receive complaints and a proper mechanism to handle complaints. Any complaint of violations of the code must first be directed to the internal complaints mechanism within the lender and, if unresolved, be directed to the industry ombudsman. The ombudsman should be empowered to grant relief, including reducing or writing down the loan. This will provide the incentive for businesses to adhere to the code and provide relief for borrowers who have been victimised. Complaints to the ombudsman will also alert the regulator to the presence of unlicensed businesses that can then quickly be shut down.

There will need to be consultation with all stakeholders to work out the details but these are the broad contours of sensible regulation.

The question is will this regulation stifle the industry to the point where borrowers turn to the village money lender? This is possible so a balance must be struck. Some (though not all) moneylenders may be even harsher in their methods of collection.Policymakers and activists need to evaluate how the regulations are working and address any shortcomings. The proposed regulations cover any form of moneylending but it is highly unlikely that the CBSL would be able to police the traditional moneylender.

The writer is an independent consultant


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