SELECTING AND APPOINTING ANKING CORRESPONDENTS

Under the business correspondent (BC) model, banks can outsource certain activities to their business correspondents. According to the RBI circulars in place, The scope of activities may include (i) identification of borrowers, (ii) collection and preliminary processing of loan applications, including verification of primary information/data, (iii) creating awareness about savings and other products and education and advice on managing money and debt counseling, (iv) processing and submission of applications to banks, (v) promoting, nurturing and monitoring of self-help groups/joint liability groups/credit groups/others, (vi) post-sanction monitoring, (vii) follow-up for recovery, (viii) disbursal of small value credit, (ix) recovery of principal/collection of interest, (x) collection of small-value deposits, (xi) sale of micro insurance/ mutual fund products/ pension products/ other third party products, and (xii) receipt and delivery of small value remittances/ other payment instruments. While the business correspondent model is a good alternative channel for mainstreaming financial inclusion services, it certainly cannot work at these low levels of bidding as servicing the last mile is extremely costly with regard to low income people. Also, as recent experience (the 2010 AP Micro-Finance crisis) has shown, there are huge risks as well and that is why it must be introduced and regulated carefully. This is especially true in the existing environment in India, where there are many controversies with regard to the kind of financial services provided to low-income people, the type of service delivery methods employed, the abnormal prices charged by the informally outsourced entities (such as centre leaders and others acting as microfinance agents who are in many ways similar to BCs). In fact, the informal outsourcing of loans disbursal and 'collecting back the loans' has led to the proliferation of 'microfinance recovery agents' who have caused tremendous hardships for clients in Andhra Pradesh and other states in the past few years! As widely noted in the media, the new breed of microfinance agents, who functioned almost like BCs, certainly seemed to have created havoc in the lives of low-income people. And these experiences certainly have strong implications for the use of the BC model that is being advocated!

IMPLICATIONS FOR SELECTING BUSINESS CORRESPONDENTS

Firstly, it is imperative for the RBI to ensure that banks have an appropriate due diligence process in selecting their business correspondents (BCs). The RBI must likewise ensure that banks avoid appointing all and sundry as their business correspondents, just to meet any internal or policy targets that may be imposed on them from time to time. Further, such due diligence processes must not just exist on paper, but rather they must be implemented in real time at the banks, and this is something that the RBI must ensure by its supervisory function through the department of banking supervision. That DFIs and the banks failed miserably to see the unethical practices in Indian microfinance that ultimately led to the 2010 microfinance crisis, is something that we should not forget at this juncture. While we tend to blame MFIs, equity investors and/or regulators largely for what happened in Andhra Pradesh in 2010, what about the role of commercial banks and DFIs? Were they not responsible in anyway? There is no doubt that without their funds and lazy attitude to supervision of priority sector loans, much of the multiple, over and ghost lending by MFIs, and strong-arm recovery practices witnessed in the past few years would not have happened. Let us be absolutely clear about that! And what is scary is that neither DFIs nor the commercial banks seem to have learnt from the 2010 microfinance crisis, to improve the supervision systems on the ground with regard to priority sector lending. Many continue to be in a denial mode, blaming the Andhra Pradesh government, when in reality they were hugely responsible for much of the mess in Indian microfinance. This is to set the record straight! Therefore, the RBI, while encouraging the use of the business correspondent model, must also ensure that the banks employ appropriate (due diligence) criteria to assess, prior to selection, a business correspondent's capacity and ability to perform the various required activities effectively, reliably and most importantly, to a high standard, together with any potential risk factors associated with using a particular business correspondent. That is very critical. I am not sure that such (appropriate) minimum criteria have been established for the (unviable) common BC bidding process that is currently underway. Second, the RBI must place emphasis on ensuring that business correspondents appointed by the banks are sensitive to the needs and situations of low-income clients and do not harass oppress them in terms of over-lending and use of strong-arm recovery tactics. Thus, the RBI must also enable the concerned banks to put in place 'adequate client protection measures' in the entire scheme of "outsourcing" their activities to BCs. And without question, RBI's supervision including on-site examination of banks must verify the implementation of these in real time. OK, given that due diligence of business correspondents by banks is critical, what should it typically include? Among other things, such due diligence should include assessments with regard to the following (not exhaustive by any means):

(1) Whether the BC is qualified and interested in performing the specified tasks? Whether the BC has successful past experience in performing the specified tasks? (2) Whether the BC understands and can meet the objectives of the Bank in performing the specified activities? (3) Whether the BC's has the financial soundness, managerial capacity and all other resources in adequate measure to fulfil its obligations and successfully perform its role as a BC and the various (outsourced) activities? and (4) Whether the BC has the reach, resources and capacity to meet any special needs of the envisaged clients and/or the bank? (5) Whether the BC has the capacity to implement sufficient risk management and client control processes on the ground while discharging its responsibilities? (6) Whether the BC has previously worked in the proposed or similar locations and has the social acceptability to work in such areas? In case the bank has any special needs - such as servicing geographically dispersed/disadvantaged clientele and/or performing any special activities for them the reach, capacity and resources of the BC must specifically be assessed with regard to such activities and they should not be outsourced to a BC who does not meet these criteria. That is critical and making the assumption that the BCs will over time acquire the expertise has, many a time, proved costly, in similar situations. Further, if a BC fails, or is otherwise unable to perform the outsourced activity, it may be costly or problematic (for the bank) to find alternative solutions. Transition costs and potential business disruptions should thus also be considered as well as the larger (regulatory and other) implications of not being able to complete such activities Lastly, additional concerns may exist if the BC to be appointed is to service a remote and/or communally sensitive area (Nizamabad in AP is one such example). In such areas, in case of an emergency or extraordinary situation, the bank may find it more difficult to implement appropriate responses in a timely fashion. Therefore, senior management of the bank may also need to assess the local or special conditions that might adversely impact the BC's ability to perform the various tasks effectively for the bank. While the above provide some guidelines with regard to assessing BCs and choosing those who meet the various criteria in terms of resources, capacity, goal congruence and other aspects, the key point that should not be missed is the aspect of doing due diligence. Banks have been very nave in choosing their partners and have consequently, found themselves in rather precarious situations. Therefore, it is sincerely hoped that they follow a proper process of selecting BCs so that there is a pareto optimal situation for all stakeholders concerned

THE MODEL HAS ITS OWN WEAKNESSES

An identity is just the first link in the cash-transfer chain. Everyone also need bank accounts that are easily accessed. A host of competing initiatives are trying to get these links up. Each is facing teething troubles. Sixty years after independence, India continues to be appallingly underbanked. According to the RBI, only 5.5% of 650,000 villages have bank branches. Further, says Skoch, a financial-inclusion consultancy, only 40% Indians have a savings account. Since 2005, the RBI has been prodding banks to open no-frill accounts (NFAs), which don't have a minimum-balance requirement. But they are not viable. Instead of setting up branches, banks are outsourcing the NFAs to businesscorrespondent (BC) firms. A BC firm has a team of agents that goes to account holders, and helps them deposit or withdraw cash using biometric cards, over handheld consoles (like FINO, A Little World, Bartronics) or through mobile phones (Eko). Between April 2010 and March 2011, RBI data shows banks expanded their coverage to 43,337 villages. Of these, only 525 villages were through branches; 42,506 were through BCs, and 306 through other modes like ATMs. This is how cash transfers are being envisaged. The UIDAI is working on the Aadhaar Payment Bridgea database that knows which UID number is linked to which bank account. Once a ministry enters a payment and the beneficiary's Aadhaar, the system routes the payment to the designated bank account. At the village level, the BC agent will take the beneficiary's fingerprints on his handheld terminal. This data travels back to a UIDAI authentication system called Aadhaar Enabled Payment Systemfor immediate verification. Once the identity is confirmed, the beneficiary completes the transaction through the agent. UIDAI is currently working on both these systems. Questions

pockmark the entire chain. One, not all bank branches and servers, especially of regional rural banks, are linked to the banking system. The RBI has told banks to do this by the end of this month. THE PROBLEM WITH BCS Two, most banks have asked their BCs to not just do transactions, but also house their NFAs. "Only 30 banks have enterprise licenses for banking software. The others pay per user," says a manager in UIDAI's financialinclusion team, not wanting to be identified. So, loading NFAs on to their core banking system is a cost without adequate returns. What this means is villagers can access their account only where their bank's BC has a presence. Where transactions are not updated real-time between the BC agent and the BC server, villagers can bank only with the agent. Once cash transfers kick off, the agent controlling the pipe through which all payments flow can become a power centre. To get around this problem, UIDAI is suggesting BC terminals be made interoperable an account holder can transact through any agent of any BC firm. But, says Anurag Gupta, founder of A Little World: "If you allow multiple BCs in a village, none will be viable." The last few years has seen new BCs. Cut-throat competition, helped by banks awarding BC contracts to the cheapest bidders, is underway. "BCs are struggling to break even," says Manoj Sharma, director, Microsave. It's rubbing off at the field level. Agents are given such large territories that they travel to each village infrequently. Villagers, unsure when the BC will come next, tend to withdraw all their welfare payments right away. Also, systems are poor, says a former employee of a BC firm, not wanting to be identified. "We had cases where deposits got credited to wrong accounts." Also, agents are more interested in chasing large customers who can, say, deposit Rs 10,000, than go after smaller ones who cannot deposit more than Rs 100. A study by Skoch found that only 11% of the 25.1 million NFAs opened between April 2007 and May 2009 were active, which was confirmed by a more recent study by Microsave. Even as BCs struggle for viability, telecom companies like Bharti Airtel and prepaid card companies like ITZ Cash are making a case to handle payments (See graphic: Beyond Banking). Bharti Airtel wants the government to send cash on people's mobile phones, which they can then withdraw at a mobile recharge point. "The business that has penetrated the deepest is telecom, with about a million customer sale points," says Abhishek Sinha, founder of Eko. But will they, or the others, get a look in.