The COCA Callout For Microfinance Institutions

Adherence to the Code of Conduct Assessment norms by microfinance institutions has enormous significance in the context of the growth and financial inclusion agenda.

The MFIs play a crucial role in promoting financial inclusion and economic empowerment of unprivileged micro-borrowers. They bridge the financial gaps by reaching the most rural, far-flung areas and typically provide small loans.

Currently, the MFI sector has more than 7 crore borrowers and impacts more than 30 crore lives. These are mostly people who have limited access to banking facilities. Indeed, almost 99% of microfinance loans in India are provided to women from low-income households. And in terms of geographical spread, rural has almost two-thirds of the pie vis-a-vis rural. 

To be sure, as much as 98% of the MFI loans are provided through the joint liability group-lending model, wherein a group of customers, usually five to 10, individually come under a JLG to take loans and agree to support and repay the loans if customers in the group face difficulty in making repayment. This group model brings efficiencies in operational costs and leverages social collateral towards underwriting and against the risks of defaults. Loans are primarily for income generating activities but are also taken for household expenses such as education, health and housing. 

So far, loan-recovery methods, interest rates and lack of a proper customer-grievance system have been among few of the pain areas. That, however, is on the mend now, with the MFIs being encouraged to adhere to a lending system that encourages transparent client relationships and feedback mechanisms.

It thus becomes imperative for the MFIs to get themselves evaluated on adherence to ethical and sound lending practices. This will ensure they operate fairly and equitably, without discriminating against any group or individual.

The COCA establishes ethical standards for credit officers of the MFIs, ensuring they demonstrate transparency, accountability and integrity while dealing with clients.

Adherence to these standards can help the MFIs reduce the risk of legal and regulatory issues and enhance their reputation, demonstrating their commitment to ethical and responsible practices. It will also strengthen trust between the MFIs and their borrowers, investors, and other stakeholders, fostering strong long-term relationships.  

In addition, the MFIs can mitigate credit risks—evaluating clients' creditworthiness and improve their asset quality and portfolio performance.

That said, there are few challenges in implementation of the COCA adherence. One, lack of clarity and awareness. Indeed, few MFIs may not be aware of the importance of having a code of conduct adherence.

Two, resistance to change. Some MFIs may resist adopting a code of conduct, especially if it requires changes in their existing practices, systems, and processes. 

Given limited financial know-how, such as calculating of interest or cash flow needed, existing and potential clients shy away from leveraging the range of products and services available with the MFIs. The imperatives, therefore, are not hard to fathom.

Given the increasing commercialisation of microfinance and the entry of for-profit players in the sector, financial literacy is a means to enhancing client protection, including fair and transparent pricing, effective communication, sensitivity to over indebting clients and ethical behaviour of staff.

Although the MFIs have been providing comprehensive group training to their clients for years to help them understand how to calculate interest, repayments or terms of their loans, regular efforts are needed, with a behaviour-change approach, to promote transparency among them through financial literacy. Clients must be made aware of loan cards, basic loan terms, rate of interest and various feedback and grievance mechanisms, as well as what to expect from collection officers. 

Responsible and sustainable growth: Ensuring transparency related to borrowers and documents, awareness related to interest rates, adherence to the COCA and sound governance is crucial in view of the vulnerable sections of the society the MFIs deal with.  

In the milieu, best practices for the MFIs can include client education, formal governance system that is transparent and professional, involving stakeholders in implementation of the COCA adherence, communicating effectively to all stakeholders, both internal and external, through channels such as training sessions, workshops. The MFIs can also provide training to their employees on the expectations and best practices to be followed.  

Besides, regular monitoring and review of adherence to the code of conduct will ensure it remains relevant and effective.

To conclude, sustainable and responsible growth of microfinance hinges on financial inclusion and well-being of borrowers. Therefore, striking a balance between financial inclusion and well-being of borrowers is crucial to ensure sustainable and responsible growth of the microfinance industry and success of various microfinance initiatives. 

Binaifer Jehani is the business head, risk solutions – assessments & social sector consulting, Crisil Market Intelligence and Analytics. Abbas Master is the associate director, risk solutions – assessments & social sector consulting, Crisil Market Intelligence and Analytics.