By Rachit Khaitan, IFMR Finance Foundation
Comments on the Revised Code of Conduct for the Microfinance Industry
M-FIN and Sa-Dhan, two key Self-Regulatory Organisations (SROs) of the microfinance industry jointly released their revised Code of Conduct for the Microfinance Industry in December 2015. The revised Code of Conduct following from the original 2011 version, is vital for setting standards of behaviour and maintaining norms through collective action, with a view to uphold client protection in the industry in line with and in some aspects beyond regulatory statutes.
In this post, a few salient and commendable features of the revised Code of Conduct are highlighted, alongside potential concerns and recommendations.
This section features an important commitment to “disclose all terms and conditions to the client, in a form and manner that is understandable, for all services offered.” It further indicates a commitment to securing clients’ informed consent and communicating details in a language understood by the client. These details include simple concepts such as all associated fees and charges but also more complex aspects such as interest and fees payable as an all-inclusive Annual Percentage Rate (APR) and equivalent monthly rate. This is in line with the RBI Guidelines for Fair Practices Code for NBFCs.
However, given the sometimes complex aspects of information that are imparted to clients, there is necessity for MFIs to better ensure truly informed consent based on demonstrated customer understanding. This could be implemented, for instance, in the form of a short verbal quiz about product features and obligations to be administered to the client at the point of sale based on some rules of thumb.
The sub-section on over-indebtedness is an important part of the Client Protection section.
It includes a commitment to “conduct proper due diligence as per [the MFI’s] internal credit policy to assess the need and repayment capacity of clients before making a loan and must only make loans commensurate with the client’s ability to repay”. This addresses a key aspect of preventing bad outcomes by verifying that loan clients are able to afford paying back the principal and the interest by the end of the loan tenure. Given the critical nature of this commitment, there is also a necessity to put in place a commitment for a Board-approved policy to ascertain client ability to repay and prevent financial distress. This would be in line with the RBI Charter of Customer Rights and the IBA Model Customer Rights Policy which includes a commitment to prepare Board-approved policy incorporating the Right to Suitability, stated as “products offered should be appropriate to the needs of the customer and based on an assessment of the customer’s financial circumstances and understanding.”
There is a concern that this does not however include a commitment to ascertain whether clients are able to make repayments without substantial financial stress throughout the tenure of the loan. For instance, liquidity mismatches between structured instalment frequencies (typically weekly or monthly) and household cashflows could lead households to take on additional loans from informal sources or sell off assets such as livestock or land at below market prices, even though such households are comfortably able to repay the loan by the end of the tenure. This concern is exacerbated by the absence of adequate savings mechanisms for MFI clients, who are oftentimes unable to safely put away relatively large sums of money for future use. There is thus a necessity to enhance the nature of MFI due diligence for better client outcomes. There is also a necessity for a commitment to design and distribute products that are appropriate and flexible to address the needs and financial situations of customers, while preventing financial distress. This is in line with the RBI Master Circular on Customer Service in Banks which indicates the role of a Customer Service Committee of the Board to address the product approval process “with a view to suitability and appropriateness.”
The sub-section also includes a commitment for an MFI not to exceed the borrowing limit of Rs. 60,000 for a JLG customer (which is lower than the RBI mandated total indebtedness cap of Rs. 100,000) in a group arrangement or to be the third lender to a client. There is a concern that such caps on lending might be restrictive to households that might have a genuine need and ability to repay higher loan amounts. Moreover, there does not seem to be clear basis for both cap values, especially when MFIs are already committing to conduct proper due diligence on client need and repayment capacity of every client.
There is an additional concern that customer data from credit bureaus may not provide a complete assessment of overall household indebtedness. Credit institutions are yet to fully act upon RBI’s requirement to report to all credit bureaus, especially in terms of loans from the bank and SHG channels, although there has been steady progress. Credit bureau data is also, at best, unable to include household debt outstanding from informal sources such as local moneylenders. There is thus a need for a commitment to better understand customer indebtedness and financial situation through customer self-reported information, which when triangulated with credit bureau information can provide a more complete assessment of household indebtedness.
The sub-section includes important commitments with regard to authenticating client identity and sharing client information. The move towards Aadhaar-based KYC within two years will commendably enable more accurate credit bureau assessments of outstanding debt. The challenges of implementing a seamless KYC interface will need to be overcome with robust yet low-cost technology solutions that enable error-proof and real-time authentication.
The new Code of Conduct lays out commitments to have in place several Board-approved policies for debt restructuring, dealing with delinquent clients, fair collection practices, and processes to raise client awareness. Board-approval is valuable for putting in place policy for important client protection aspects that is pervasive across all levels of an MFI. This is therefore a very progressive development.
There is also a commendable commitment to prepare a monthly report on grievances received, resolved, and pending for senior management review and periodic reports to the Board. However, by the same rationale as the commitment on audit and compliance, there needs to be an additional commitment for appointing an independent grievance redressal committee that is directly accountable to the Board. This is in order to prevent a potential conflict of interest that operations staff could face leading to under-reporting of customer grievances.
The new Code of Conduct also includes an important section that outlines the rights of a customer, in addition to commitments from participating MFIs, in similar vein as the RBI Charter of Customer Rights. There are customer rights outlined to ascertain terms and conditions and current status of the loan and avail necessary documents and receipts, which are in line with the RBI’s Right to Transparency, Fair and Honest Dealing. There are also customer rights outlined to access a grievance redressal mechanism with the help of designated staff, receive acknowledgment and a response to grievance within a prescribed time limit, and appeal to a higher internal level or an external redressal mechanism (the nodal office of the RBI) if desired, which are in line with the RBI’s Right to Grievance Redress and Compensation. Other rights outlined in the RBI Charter, including the Right to Fair Treatment and Right to Privacy are included as commitments to customers, although given their relevance, need to be included as rights as well. Finally, there is a need for a stronger commitment and customer right to Suitability.
 SEEP Network – Codes of Conduct and the Role of Microfinance Associations in Client Protection (2012): http://www.seepnetwork.org/codes-of-conduct-and-the-role-of-microfinance-associations-in-client-protection-resources-345.php
 RBI Master Circular – Fair Practices Code (July 2015): https://rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9823
 RBI Charter of Customer Rights (December 2014): https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=32667
 IBA Model Customer Rights Policy (January 2015): http://www.iba.org.in/Model%20Policy/Model_Customer_Rights_Policy_Amended_Final_27_1_15.pdf
 RBI Master Circular on Customer Service in Banks (July 2015): https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=9862
 RBI Master Circular on PSL Targets and Classification (April 2015): https://rbi.org.in/Scripts/NotificationUser.aspx?Id=9688&Mode=0#ANN
 RBI Directive on Membership of Credit Information Companies (CICs):
 Article on Livemint (August 29th, 2015): http://www.livemint.com/Industry/FRgAFR9Clo3nvMCdGFl37L/MFI-credit-bureaus-comb-client-data-to-smooth-microloans.html
 RBI Charter of Customer Rights (December 2014):