By Nachiket Mor and Bindu Ananth
The financial sector crisis in Andhra Pradesh seems to be playing out like a very bad dream that doesn’t end. It has been 33 days since the State Government of Andhra Pradesh passed a sweeping Ordinance governing all lending activities in the state by banks as well as non-bank finance companies (with only perhaps State Bank of India excluded from its ambit since it is not constituted as a company under the Companies Act but through its own Act) with stipulations that no collateral may be taken, repayments must be monthly, nobody must have more than one loan outstanding, all financial services business must be carried out in government offices and the permission of government agencies must be taken before any loans can be taken. Quite aside from the number of fundamental rights of its own citizens that the Ordinance infringes upon, it directly challenges the competence and the capacity of the Reserve Bank of India (RBI) to govern the financial system in the state since both sets of entities are directly regulated by it and given their systemic importance have been subjected to several rounds of supervisory audits over a number of years.
Not surprisingly, this political event has led to large scale defaults taking place inside the State and as on date, most banks and non-banks are in violation of the provisions of the Ordinance in one way or another, making their directors (including independent directors) liable for imprisonment. What is very surprising though is the complete absence of any public statement either from the Central Government or from the Reserve Bank of India. The last time something similar happened in Andhra Pradesh was in 2006 in Krishna district and both the RBI and the Central Government acted swiftly and brought an end to the crisis and did not allow it to spread beyond one district. This time around over a month has passed without any word from both these entities and there is a fear that, emboldened by this tacit encouragement, other State Governments will follow suit. Since this is a very real possibility, all banks and capital market participants have immediately stopped extending any funding to non-bank finance companies on a nationwide basis. In particular, focus has been on those RBI regulated non-bank finance companies whose businesses have enjoyed a priority sector tag on account of the criticality of their operations for the wellbeing of weaker sections of society.
This complete withdrawal of liquidity combined with the loss of capital that is sure to follow from all these defaults points to a likely collapse, on a nationwide basis, of financial services infrastructure that serves 2 crore low-income households with significant NPA implications for the banking system. Ironically, we may be one of the few countries in the world to have escaped the contagion effects of the 2008 global financial crisis on account of a robust economy but we will very likely be the first country in world where a crisis was created directly by the actions of a state government that ought to have acted in the role of a protector.
While there are many aspects of the situation that need to be addressed, we would like to comment on three key aspects that seem particularly salient to us:
1. The dangerous rhetoric that microfinance is unregulated and has hence, run amok.
In the past few weeks, we have heard several proposals for regulation of the microfinance sector. This impression has gained currency principally because Reserve Bank of India has chosen not to publicly reaffirm the fact that 80% of the microfinance sector is directly regulated by them. In fact all Non Bank Finance Companies (NBFCs) are regulated by the Reserve Bank of India, and the systemically important ones with an asset size over Rs. 100 crore are subject to stringent financial standards, monthly reporting requirements as well as a Fair Practices Code (See: RBI Circular No. DNBS (PD) CC No.185 / 03.10.042 / 2010-11 dated July 1, 2010) that specifically prohibits NBFCs from resorting to “undue harassment” for recovery of loans. The Fair Practices Code for NBFCs also makes it clear that the Board of each NBFC is free to “adopt an interest rate model taking into account relevant factors such as cost of funds, margin and risk premium and determine the rate of interest to be charged for loans and advances.
The RBI has made it mandatory for NBFCs to disclose explicitly in the application form for loan and other relevant documents, the rate of interest and the approach for gradations of risk and rationale for charging different rate of interest to different categories of borrowers. All of these regulations govern NBFCs that lend to rich as well as those that lend to the poor (popularly referred to as MFIs). If there is a need for more regulation on any aspect of MFI operations, including customer protection, by all means the RBI must take it forward but it is important to note that the sector is already very tightly regulated.
2. The root of the repayment crisis in AP is not large-scale wilful defaults by customers but orchestrated action by the state government to shut down collections.
In all this talk about ‘crisis’, let us not forget that collection rates were in the high nineties prior to the State Government of Andhra Pradesh stepping in with its Ordinance and directly causing this crisis. It must also be noted that outside of Andhra Pradesh, MFI collections continue to be high. Comparisons to the US sub-prime are ridiculous because in this case, the customer has forcibly been prevented from repaying the lender and actively exhorted to do. Government cited a few anecdotal, impossible-to-verify-or-attribute events as the basis of such a massive intervention.
3. The Ordinance itself over-steps the right of the legislature, impinges on the fundamental right of citizens.
The most glaring aspect of the Ordinance is that it completely takes away the rights of the poor to decide for themselves – since it seems to specifically target “low income households” for these restrictions – presumably leaving all of those of us that hold multiple credit cards and home loans untouched, at least for the time being.
For example, it prohibits all those that are registered with State Government managed Society for the Elimination of Rural Poverty (SERP), which includes more than 50% of all women in the State, from taking more than one loan at a time. Research shows that people usually take multiple loans because one loan is not able to meet all their requirements. Just to illustrate, a woman needs at least Rs. 8,000 to buy a buffalo whereas an average SHG loan is only Rs 4,000. If all the other formal lenders are now barred from serving her, she will necessarily have to turn to informal sources. The Ordinance will serve to further the outreach of traditional moneylenders in this manner and perhaps that is its true intent. The fact that women were the main beneficiaries of these programmes makes the situation even more poignant because they are the ones who will bear most of the burden of these failures and despite that, given their powerlessness within the community, their voices of protest are not being heard.
The Ordinance requires all borrowers to repay all their loans only on a monthly cycle and to continue to pay interest on the loan for a longer period of time. Do the authors of the Ordinance think that these women have monthly salaries? Most of them have daily or weekly income from labour or small trade. Weekly repayments that take place at her door-steps are usually easier for her, because they match the wage frequency of most of them. Monthly repayment requires women, who usually do not have access to a safe place to save, to put sums aside and wait to repay till the end of the month hoping that money does not get stolen in the interim and to pay an additional amount of interest on the loan not having earned anything on the savings.