By Deepti George, IFMR Finance Foundation

Continuing on our series on ‘Consumer Protection’, we will take a look at how consumer protection has found its place within the regulatory architecture of select countries, namely Australia and South Africa. A previous post had dealt on the emergence of the twin-peaks model in Australia. In this post, we briefly describe the regulatory principles that form the basis for the Australian regulatory reform process that began with the Government’s implementation of the Wallis Inquiry recommendations.

In June 1996, the Financial System Inquiry¹ (known as the Wallis Inquiry) was established to:

i. Examine the results of the deregulation of the Australian financial system
ii. Examine the forces driving further change, particularly technological; and
iii. Recommend changes to the regulatory system to ensure an ‘efficient, responsive, competitive and flexible financial system to underpin stronger economic performance, consistent with financial stability, prudence, integrity and fairness.

Chapter 5 of the Wallis Inquiry report outlines the regulatory principles that the new structure was based on. The Inquiry identifies five regulatory principles, as given below:

Competitive Neutrality

Competitive neutrality requires that the regulatory burden applying to a particular financial commitment or promise apply equally to all who make such commitments. It requires further that there be minimal barriers to entry and exit from markets and products; No undue restrictions on institutions or the products they offer; and that markets are open to the widest possible range of participants.

Cost effectiveness

A cost-effective regulatory system requires a presumption in favor of minimal regulation unless a higher level of intervention is justified; an allocation of functions among regulatory bodies which minimizes overlaps, duplication and conflicts; an explicit mandate for regulatory bodies to balance efficiency and effectiveness; a clear distinction between the objectives of financial regulation and broader social objectives; and, the allocation of regulatory costs to those enjoying the benefits.

Transparency

Transparency of regulation requires that all support/guarantees from the regulator or the government to financial institutions be made explicit and that all purchasers and providers of financial products be fully aware of their rights and responsibilities, and that financial promises (both public and private) be understood by all parties concerned.

Flexibility

The constant evolution of the financial system makes flexibility critical. The regulatory framework must have the flexibility to cope with changing institutional and product structures without losing its effectiveness.

Accountability

Regulatory agencies should operate independently of sectional interests and with appropriately skilled staff. In addition, the regulatory structure must be accountable to its stakeholders and subject to regular reviews of its efficiency and effectiveness.

The Twin-peaks model of Australia encompasses two agencies, besides the Reserve Bank of Australia: The Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC). ASIC is Australia’s corporate, market and financial services regulator, which includes being the regulator for consumer credit. The Australian Securities and Investments Commission Act 2001 made ASIC responsible for the following:

1. Maintain, facilitate and improve the performance of the financial system and entities in it
2. Promote confident and informed participation by investors and consumers in the financial system
3. Administer the law effectively and with minimal procedural requirements
4. Enforce and give effect to the law
5. Receive, process and store, efficiently and quickly, information that is given to it
6. Make information about companies and other bodies available to the public as soon as practicable

ASIC’s priorities therefore include ensuring that investors and financial consumers are confident and informed, promoting fair and efficient financial markets and ensuring efficient registration and licensing.

ASIC administers the following functional areas through specific legislations:

Australian Financial Services License (AFS)

ASIC administers the Financial Services Reform Act 2001 that introduced a single licensing regime for all financial services and products. This piece of legislation was later incorporated into chapter 7 of the Corporations Act 2001.This legislation requires those who carry on a business of providing financial services to hold an Australian Financial Services (AFS) licence. An AFS licence is required for entities that:
• Provide financial product² advice³
• Deal in a financial product
• Make a market for a financial product
• Operate a registered managed investment scheme
• Provide a custodial or depository service
• Provide traditional trustee company services

The obligations of an AFS licensee, as mandated by law, include:

• Obligation to ensure that financial services offered are provided efficiently, honestly and fairly
• Obligation to meet adequate financial requirements (e.g. solvency and cash obligations) to provide financial services and to carry out supervisory arrangements
• Obligations to meet compliance and risk management requirements if the licensee is not a APRA-regulated body
• Obligation to maintain competence to provide financial services (both technological and human resources)
• Obligations of monitoring, supervising and training of authorised representatives in order that they comply with the financial services laws
• Conduct and disclosure obligations
• Obligation to manage conflicts of interest
• Obligation to establish and maintain dispute resolution (internal and external) mechanisms
• Obligation to have prescribed compensation and insurance arrangements
• Obligation to comply with requirements set out by ASIC from time to time

In the next post in this series, we will focus on the conduct and disclosure obligations that need to be met by all AFS license holders and its implications for providers and consumers of financial services.

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1 – http://fsi.treasury.gov.au/content/FinalReport.asp
2 – As pre Corporations Act 2001, Chapter 7.1, Div 3,“For the purposes of this Chapter, a particular facility that is of a kind through which people commonly make financial investments, manage financial risks or make non cash payments is a financial product even if that facility is acquired by a particular person for some other purpose”.
3- Financial product advice is a recommendation or a statement of opinion, or a report of either of those things, that is intended to influence a person or persons in making a decision in relation to a particular financial product or class of financial products, or an interest in a particular financial product or class of financial products.

Close on the heels of launching its fourth KGFS, IFMR Rural Channels launched its fifth KGFS yesterday – Thenaaru Kshetriya Gramin Financial Services (KGFS) which would be serving the districts of Pudukkotai, Karur and Namakkal in Tamil Nadu. The first branch has been opened at Nagarapatti in Pudukkottai District.

As an entity KGFS aims at delivering a complete suite of products and services to ensure financial wellbeing of households and enterprises in remote rural locations under its unique wealth management approach.

Apart from the recently launched Thennaru KGFS & Vellaru KGFS, the other operational KGFSs include Pudhuaaru KGFS (Thanjavur, Tamil Nadu), Dhanei KGFS (Ganjam, Orissa) and Sahastradhaara KGFS (Uttarakhand).

Images from the Nagarapatti branch launch:

By Kenny Roger, Center for Microfinance, IFMR Research

A recent report titled “Latest findings from Randomized Evaluations of microfinance” by Jonathan Bauchet, Cristoball Marshall, Laura Starita, Jeanette Thomas and Anna Yalouris, throws a lot of interesting insights into the realm of randomized evaluations and how they are being increasingly used by researchers across the globe to better understand financial services for the poor and the impacts achieved when an appropriate financial intervention is introduced.

Some of the recent interventions include the following:

• Researchers evaluated the impact of access to credit by randomizing the placement of MFI branches across a particular region in India. Though its early days to say there has been a considerable impact, it is notable that some households increased non-durable consumption, others reduced expenditure on temptation goods and instead invested in their business or bought more durable goods.
• Fingerprinting intervention in Malawi saw borrowers take smaller loans for instance, when they knew they could be identified, and were more likely to repay as well because of the fingerprinting.
• Changing term structure of debt actually witnessed borrowers investing a greater portion of their loans in businesses and thus registering higher average profits.
• One study in Kenya showed that access to formal savings accounts for market stallholders led to increased business investment and personal income growth.
• There are also instances wherein farmers who had access to rainfall insurance began to shift more towards risky and rain-sensitive crops owing to its capability of generating high profits.

These studies have however studied only one financial product or aspect at a time. The needs of the poor are varied like any other income group and the scope of availability of a wide range of financial services to the same as we all know may not be good enough.

To put things into perspective, consider, Mr A, a farmer by profession who has a bank account, has taken an MFI loan, borrowed money from moneylenders, has remittances from a direct relation and has a life insurance policy. We need to realise that Mr. A, like anyone, is involved in a wide range of financial products or services regardless of whether the provider is formal or informal. A study looking at such a wide set of financial services and how access to the same impacts a person has not been done yet.

To address this, the Center for Microfinance (CMF), IFMR Research, along with Harvard University is studying the impact of access to a broad range of financial services provided by Kshetriya Gramin Financial Services (KGFS) in two districts of Tamil Nadu. KGFS uses a thin customer-facing front-end with robust back-end technology to bring a full range of financial services, along with wealth management advice, to entire communities under its coverage area.

Using a randomized control trial methodology the study aims to understand the specific pathways in which access to a range of financial services can impact not only individual households but also the entire village economy. The outcomes of this study will help in designing products and delivery channels for low income households, as well as inform policy on financial inclusion both for India and the rest of the world.

Highlights of this study will be shared as a series in subsequent blog posts.

IIM Ahmedabad recently interviewed Bindu Ananth and Nachiket Mor for their publication ‘The Efficient Frontier’. The publication was recently rebranded to mark the institute’s Golden Jubilee year.

In this interview, Bindu Ananth and Nachiket Mor discuss the applications of financial engineering to low income  households.

Excerpt from the interview

In your experience with low income households, what are some of the risks which you have seen them facing and which you feel could be solved by financial engineering? What are some of the products that can be used to mitigate these risks?

For most low-income households – human capital, in the sense of present value of lifetime net incomes, tends to be the biggest asset in their portfolio. Given fairly low levels of financial capital/wealth, the reliance on human capital is very high in order to successfully meet household goals over a period of time. Anything that impacts this human capital then tends to become very critical for these households….

Click here to download the publication.

IFMR Rural Channels launched its fourth KGFS – Vellaru Kshetriya Gramin Financial Services to serve Ariyalur, Perambalur and Cuddalore districts of Tamil Nadu. This is in addition to Pudhuaaru KGFS (Thanjavur), Dhanei KGFS (Ganjam, Orissa) and Sahastradhaara KGFS (Uttarakhand). The KGFS network has 106 branches that serve about 200,000 households in these regions.

The KGFS model is aimed at improving the financial well-being of households and enterprises in remote rural India by providing them access to a comprehensive range of financial services. Its wealth management approach emphasises understanding each household and customising a portfolio of financial services to meet its unique requirements.

At the Vilagam branch of Vellaru KGFS

Speaking at this occasion, Anil Kumar S.G, CEO, IFMR Rural Channels said, “This is another important milestone in our journey towards achieving our mission. Over the past few months we have worked on completing our suite of products, which now includes Pensions and term life among other products. We have also been able to make significant progress on our wealth management approach. The branches in the new entity would be offering this complete suite of products under the wealth management framework.”

By Mohan R, IFMR Rural Finance

Given the important role pensions play in the financial well-being of households, NPS-Lite, a pension plan geared towards economically disadvantaged populations, is crucial to achieving complete financial inclusion. It provides a mechanism for households to plan for their retirement years by saving and investing small amounts through their productive life stages.

Being one of the first aggregators appointed by the Pension Fund Regulatory and Development Authority (PFRDA) for the distribution of NPS-Lite, IFMR Rural Finance can appoint facilitators for itself to increase access to NPS-Lite. Correspondingly, to ensure that the selected facilitators are well equipped to distribute the product responsibly, it has also taken the initiative to develop content for creating awareness and providing relevant training that would aid the distribution of the product.

Towards this end IFMR Rural Finance recently completed its second modular replication with an MFI based in Bihar, Saija Finance Private Limited, by appointing it as a facilitator for IFMR Rural Finance; an important initial step towards appointing many other institutions who have shown interest in offering NPS-Lite. IFMR Rural Finance had earlier appointed Care NGO Partners as facilitators for NPS-Lite.

Commenting on being appointed as a facilitator, Purshottam Ranjan, Operations Manager, Saija Finance Private Limited, said “Having launched NPS Lite for pilot-test at our Danapur branch, we have provided exclusive training to our field staff about the product and have been promoting it at group meetings to our clients and non-clients in order to get their feedback and develop strategies based on it. Initially we are promoting the product within 5KM radius of our branch, but hope to expand as we gain experience in distributing it.“

Given that access to a complete suite of financial products is key to improving a household’s financial well-being, IFMR Rural Finance hopes to offer consulting/technical assistance/systems and training, that would help a range of institutions distribute mutual funds and insurance, amongst other products, over a period of time.

In the current edition of Economic & Political Weekly, Anand Sahasranaman of IFMR Finance Foundation has published a paper on Panchayat Finances based on an analysis of three villages – Pallavapuram, Pandiyapuram and Cholapuram in rural Tamil Nadu. The paper outlines the different aspects concerning their finances and infrastructure and argues that with judicious increases in their tax and fee regimes, all three will be in a position to self-finance a substantial portion of their infrastructure and service needs, resulting in improved local governance and quality of life of local citizens.

Abstract from the paper below:

One of the key tests to real empowerment of panchayats lies in the ability of local self-governing institutions to finance their own expenditures through internal generation of resources. Based on an analysis of three villages in Tamil Nadu, this paper argues that many gram panchayats are today in a position to substantially finance themselves and build a culture of self-sufficiency, independence and accountability to their citizens, reducing their dependence on devolutions from state governments. It concludes that by incentivising competition among panchayats and instituting a rural development fund to enable them to access debt capital, the perverse incentives they now face can be mitigated to a large extent, leading to several significant positive outcomes.

To read the full paper click here.

A recent article in the Harvard Business Review on new approaches to funding social enterprises cites IFMR Capital’s work in securitisation and structured finance of microfinance loan portfolios. The article explores how unbundling societal benefits and financial returns can dramatically increase investment.

The authors argue that financial engineering can be a powerful force for change. It can permit the mobilization of more capital for investment than would otherwise be available. It can generate rich opportunities to fund projects that fuel economic growth and improve people’s lives.  The article also mentions that the ability of social enterprises to provide their products and services rises or falls with the availability of capital and that the lack of funding opportunities is one of the major disadvantages social enterprises face. The article offers the insight that the funding of a social enterprise can be treated as a problem of financial structuring: the enterprise can offer different risks and returns to different kinds of investors instead of delivering a blended return that holds for all investors but is acceptable to very few.

This new approach to structuring can close the financial-social return gap.  The article goes on to discuss the various types of financing-innovation in practice such as loan-guarantees, quasi-equity debt, pooling and social-impact bonds. In the context of techniques that involve pooling and creating tranches, the article mentions IFMR Capital’s work in securitising microfinance loan portfolios in which an investment share is retained by IFMR Capital. The article also reviews the lessons the financial crisis has taught us, most importantly, the importance of standards and ratings and the need for transparency.

The authors conclude by stating that the challenges involved in creating fully functioning capital markets and legal frameworks to serve social enterprises cannot be underestimated and that some innovations may not be suitable for all organisations. However, with the right market infrastructure and legal framework in place, enormous amounts of private capital could be mobilised for social enterprises.

To read the complete article, click here.

The Centre for Micro Finance, IFMR Research, published its latest report “Five Years of Researching Financial Services for the Poor” at its recently concluded annual conference held in association with RBI’s College of Agricultural Banking.

Founded in 2005, the report presents the different research studies, which CMF has undertaken over the years in the area of financial services for the poor. The report, organised thematically, under its broad focus areas of “Financial Inclusion”, “Livelihoods” & “Social Objectives”, describes the organisation’s current work and summarises key findings from completed studies. The report also identifies potential areas for future research and recommends ways that financial services practice could evolve to meet the needs of low-income households.

Some of the studies that are profiled in the report include:

• Miracle of Microfinance? Evidence from a Randomized Evaluation
• The Impact of Access to Finance in Rural Tamil Nadu: Evidence from a Randomized Control Trial
• The Economic Returns to Social Interaction: Experimental Evidence from Microfinance
• Targeting the Hard-Core Poor: An Impact Assessment
• Measuring the Impact of Providing Futures and Spot Prices of Crops to Farmers

To read the full report click here.

Subsequent to our earlier posts detailing the three broad themes from the IFMR Financial Systems Design Conference 2011, Day 2 of the conference witnessed participants identify pathways to achieve the specific visions that were formulated across the sessions in Origination, Risk Transmission and Aggregation. These pathways have been segmented into the categories of Research, Regulation, Innovation and Public Infrastructure.

I. Research

1. Conceptually, what are the trade-offs, if any, between financial inclusion and systemic risk? Are there particular models of financial inclusion that fare better than others as viewed from this perspective?

2. Are there market based instruments (ex: listed subordinate debt) that provide additional information regarding the health of systemically important financial institutions? Can these effectively supplement supervision-based information?

3. How critical is priority sector regulation to the flow of credit to sectors such as agriculture and SME? Does priority sector regulation cause allocative inefficiencies in the economy? Are there less distortionary measures to direct resources to some sectors that have a high perceived social return?

4. Does structuring Government ownership in financial institutions differently reduce distortionary effects? For ex: holding company structure to channel all Government investments into financial institutions versus direct Government investments into specific financial institutions.

5. How must the performance of Chief Risk Officers in financial institutions be measured? How should their compensation be structured?

6. Financial advice as a function of originators. How is this best structured? What liability must the originator have for advice provided to clients? How must financial advisors be compensated? What is the corresponding regulatory and legal framework for customer protection in India?

7. How different are customer outcomes in an environment characterised by: (a) Financial product access alone and (b) Financial product access combined with financial advice?

8. Why is the take-up for risk transmission products (principally insurance) low at a household level? Is the selling process and agent incentives creating barriers to take-up?

9. In markets like India, what is the inter-play of hard information and soft information for credit origination? Do regionally focussed originators have better soft information? Why are non-bank institutions much more successful in some segments (ex: used commercial vehicles finance, microfinance) than banks?

II. Regulation

10. How should regulation of the financial system be structured given that the product level distinctions are blurring? Is there a need for distinct regulators for systemic risk and customer protection?

11. The conference highlighted that the roles of the regulator and the policy-maker are quite distinct? Is increasing financial access in an under-served market like India a policy objective or a regulatory objective? How should these be coordinated?

12. What are the inherent conflicts of interest in the way regulation is currently structured? How can they be addressed?

13. How should financial sector regulators be governed?

14. With increasing sophistication of markets and products, risk measurement capabilities of regulators will become important. What are the best ways to build regulator capacity?

15. What data and reporting standards aid transparency, particularly in the regulation of systemically important financial institutions?

16. Are there market based instruments (ex: listed subordinate debt) that provide additional information regarding the health of systemically important financial institutions? Can these effectively supplement supervision-based information?

17. Managing moral hazard is important while regulating credit risk transmission mechanisms. Conference emphasised the importance of adequate capital at risk for originators that participate in securitisation as an example of this.

III. Public Infrastructure

18. Payment system innovations crucial to better origination. There are several important developments in India in this regard, including the Interbank Mobile Payment Service (IMPS) and UID-linked electronic transfer of benefits. These need to be further strengthened. Cash dematerialisation infrastructure is also an important element of this.

19. Well-defined frameworks for bankruptcy/resolution are important to orderly development of markets.

20. Need to develop electronic records for collateral and collateral transfers. This includes land, house titles and vehicles.

21. Development of cyber security and privacy laws an important complement to financial sector development.

22. Expansion of broadband connectivity will have important implications for how originators are structured. Real-time data transfer has some off-set on originator-related risk.

IV. Innovation

23. Can transactional information/behaviour available with utilities and telcos provide originators information about credit risk and substitute for soft information/collateral? This might enable newer kinds of originators and under-writing processes in the near future.

24. Technological development is gradually eliminating economies of scale in origination. It may be possible to have smaller sized but efficient originators going forward. As a related point, the justification for mega-sized financial institutions that pose serious systemic risk may get diminished.

25. The Conference noted the need for much more product innovation, both for origination as well as risk transmission. Examples include commodity options, inflation indexed bonds and corporate bonds.

A summary of the overall Conference’s proceedings is available here for further reading.