MICROCAPITAL BRIEF: Due Diligence Critical as Indian Banks Select Business Correspondents to Downscale to Microfinance, Opines Ramesh S Arunachalam

Indian rural finance practitioner Mr Ramesh S Arunachalam recently addressed the need for due diligence in the business correspondent (BC) model that the Reserve Bank of India (RBI), India’s central banking authority, adopted in 2010 to increase financial access for low-income people [1]. Under the model, banks can “outsource” certain activities to their BCs such as evaluating the creditworthiness of a borrower, disbursing loans, collecting repayments and cross-selling other financial products. Microfinance institutions (MFIs), cooperatives, post offices and for-profit retailers are among those eligible to act as BCs, although non-banking financial companies are not.

Mr Arunachalam says that given the “microfinance crisis” in 2010 that began in the state of Andhra Pradesh, it is important to ensure that banks employ an appropriate due diligence process in selecting their BCs. He enumerates some key assessment criteria that the process should include such as: (1) a commitment to low-income people; (2) an understanding of financial inclusion and its principles; (3) capacity to perform the activities ethically; and (4) the ability to cater to the special needs of the excluded clients. Additionally, the banks need to consider transition costs and contingency plans in case a BC becomes unable to carry out its operations.

By Nisha Koul, Research Associate

About Reserve Bank of India: Established in 1935, the Reserve Bank of India (RBI) undertakes consolidated supervision of the financial sector comprising commercial banks, financial institutions and non-banking finance companies (NFBCs). The current focus of RBI is to supervise financial institutions, consolidate accounting standards, resolve legal issues in cases of banking fraud, monitor non-performing assets and supervise the rating model for the banking sector. In 1979, the National Bank for Agriculture and Rural Development (NABARD) was formed at the behest of RBI to provide regulatory oversight to regional rural banks (RRBs) and to promote the development of agricultural lenders: tasks that had been the responsibility of RBI. While all microfinance institutions (MFIs) and non-banking financial companies still operate under RBI regulations, the responsibility for inspecting nonprofit MFIs, agricultural lenders, RRBs, state cooperative banks, district central cooperative banks and state cooperative agricultural and rural development banks was transferred to NABARD. RBI maintains these responsibilities for for-profit MFIs. Although RBI was originally the parent organization of NABARD and until October 2010 held a 72.5 percent stake in the outfit, RBI owns a one-percent stake in NABARD as of 2011.

Sources and Additional Resources:

[1] Moneylife, “The need for due diligence for business correspondents who deliver financial services to low-income people,” http://www.moneylife.in/article/the-need-for-due-diligence-for-business-correspondents-who-deliver-financial-services-to-low-income-people/19840.html

MicroCapital.org story, July 7, 2011, “MICROCAPITAL BRIEF: Indian Microfinance Institutions (MFIs) May Become Business Correspondents (BCs) for Commercial Banks,” https://www.microcapital.org/microcapital-brief-indian-microfinance-institutions-mfis-may-become-business-correspondents-bcs-for-commercial-banks/

MicroCapital.org story, October 16, 2010, “MICROCAPITAL BRIEF: Reserve Bank of India (RBI), in Move to Expand Rural Financial Access, Updates Guidelines to Allow Individuals, Nonprofits and Corporations—But Not Microfinance Institutions—to Serve as Business Correspondents for Banks,” https://www.microcapital.org/microcapital-brief-reserve-bank-of-india-rbi-in-move-to-expand-rural-financial-access-updates-guidelines-to-allow-individuals-nonprofits-and-corporations%E2%80%94but-not-microfinance-institution/

MicroCapital.org story, December 13, 2010, “MICROCAPITAL BRIEF: Intellecap Publishes White Paper Analyzing Events Leading Up to Andhra Pradesh Microfinance Lending Crisis and State, Media Responses to the Crisis,” https://www.microcapital.org/microcapital-brief-intellecap-publishes-white-paper-analyzing-events-leading-up-to-andhra-pradesh-microfinance-lending-crisis-and-state-media-responses-to-the-crisis/

MicroCapital Universe Profile: Reserve Bank of India, https://www.microcapital.org/microfinanceuniverse/tiki-index.php?page=Reserve+Bank+of+India+%28RBI%29

Browse the MicroCapital Universe and add your entry to the wiki at https://www.microcapital.org/microfinanceuniverse/

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