RBI ban on 3rd-party loan recovery agents not a fix. It’s like AP’s microfinance ban mistake

RBI has barred Mahindra from deploying third-party loan recovery agents. But a complete ban is justified only if the problem is systemic.

28 September, 2022
The Print

The Reserve Bank of India recently banned Mahindra Finance from the use of third-party recovery agents after the death of a borrower in Jharkhand. The incident and the diktat raise key questions surrounding the regulation of loan recovery and challenges of the credit industry.

Delayed payments and defaults are part and parcel of lending. No matter how good the credit evaluation process, out of every 100 loans, some will always go bad. It is in the lender’s interest to collect as much as possible because losing money on loans implies that the business of lending can become unviable. Coercive collection practices are, therefore, a challenge for regulators of credit markets across the world, and in India.

It is no surprise that the RBI had to take some action in response to what it saw on the ground. In the past too, the RBI has been responsive to these challenges and has stepped in when recovery agents of lenders have misbehaved with borrowers. However, it is worth pondering if a more proportionate response would have been to impose a penalty instead of a complete ban on deploying third-party recovery agents. This is what it chose to do in the case of Bajaj Finance in 2021, after giving it a show-cause notice and an opportunity to defend itself.

A complete ban is justified if the problem is systemic, that is, if a large proportion of the third-party staff is found to engage in poor loan recovery practices. But the current action is similar to that of the Andhra Pradesh government, which effectively banned micro-finance in the state in 2010 in response to alleged coercive actions by a few. This proved to be expensive to the very borrowers that the ban sought to protect. In this case also, by forcing an organisation to keep staff on payroll, we run the risk that lenders may increasingly find it expensive to operate in riskier markets, thereby hampering our goals of increased financial inclusion.

The challenging landscape of retail credit

First, the credit landscape becomes challenging in markets where the cost of capital for lenders is high. Second, macroeconomic circumstances make it difficult for lenders to raise money and for debtors to repay. Third, lenders have to deal with a cash economy. Fourth, legal frameworks to deal with recovery and insolvency are weak.

India is a combination of all of the above factors. Non-Banking Finance Companies (NBFCs) typically lend to customers that banks find risky, and have a higher cost of funds. Unlike banks, they cannot raise deposits. After the Infrastructure Leasing & Financial Services (IL&FS) and Dewan Housing Finance Corporation Limited (DHFL) crisis, mutual funds that were a source of funding for NBFCs became cautious, raising borrowing costs further. The current macroeconomic uncertainty on account of high inflation worldwide, and the war in Ukraine could not have helped with funding costs. There was a spike in Non-Performing Assets (NPAs) during the Covid-19 pandemic, and several debtors are probably still reeling under the aftermath of repeated lockdowns, thus impacting NBFC balance sheets. In cash economies, lenders have to hire professionals who can actually be on the ground and physically collect money from the debtor. Lenders perhaps find it economical to hire third-party agents to do the collections instead of having staff on their payroll. While it is possible for debtors and lenders to restructure loans, the legal framework to facilitate such interactions appears weak.

In addition to these challenges, the RBI has been trying to regulate the larger NBFCs just like it regulates banks on account of concerns over financial stability. For example, the new RBI norms requiring NBFCs to recognise NPAs on a daily due date vs the month-end practice are expected to increase provisioning requirements starting 1 October 2022. But the more it treats larger NBFCs like banks, without giving them a banking license, the more squeezed the NBFCs are going to become. At an extreme, lenders may decide to fully withdraw from markets where the cost of collection makes it uneconomical to lend. And here lies the challenge of financial inclusion, financial stability and debt recovery.

Regulating credit

There is no question that coercive collection practices are unacceptable. Two approaches can prove helpful. First, regulations on coercive collection need to outline the penalties for specific individuals or firms that are found guilty. Only if bad behaviour is systemic should outright bans be deployed. If a ban is seen as the appropriate tool, then it should be part of the regulations so that lenders are aware of the kind of regulatory action they can expect.

Second, we need to find mechanisms that make restructuring more feasible than they currently are. Previous efforts by the RBI in setting up restructuring programmes resulted in the evergreening of loans. This has perhaps made the regulator cautious about designing more such schemes. However, informal restructuring must happen frequently. For instance, how can the right incentive structures be set so that we can buy debtors more time to make their repayments, and for lenders to refrain from indulging in evergreening or making large provisions on loans in the process of being restructured?

The NBFC sector plays an important role in taking finance to those customers whom banks are not willing to serve. The challenges in loan recovery need to be seen in light of overall stress in the sector and the economy. This will help design policy measures that can take us forward on the path of financial inclusion.

Cyrus Mistry tragedy shows road safety is not limited to seatbelts

The govt has admitted to the design of roads often being faulty. It is now aiming to take actions to improve curves on highways and identify black spots.

14 September, 2022
The Print

The tragic accident of businessman Cyrus Mistry and his fellow passengers in a car crash flooded our newsfeed last week. What followed was a deluge of WhatsApp messages on the importance of driving skills, seat belts and speed limits. Road safety is, however, as much about the design and construction of roads, and post-crash emergency care, as it is about seat belts. This has also been emphasised by the World Health Organization and United Nations in their Global Plan for Road Safety 2021-2030.

India has a National Road Safety Policy and has set up state-wise District Road Safety Committees to review road accidents, their causes and develop safety plans. It passed the Motor Vehicles Amendment Bill in 2019, while the Union Ministry of Road Transport and Highways also rolled out a State Support Programme of over Rs 7,000 crore for strengthening road safety. Yet, we find ourselves topping the world fatality charts year after year. This is as good a time as any to ask—why are we a failure in road safety?

Analysing failure

Depending on who you ask, the diagnosis will range from drunk driving, untrained drivers, casual drivers without seat belts and helmets, culture of speeding (especially by two-wheelers), cattle and people jostling for space on roads to poor quality and bad road design. One would think that there is someone who knows the correct answer, perhaps someone who can tell us the share of each reason for total accidents. We would then know the difference between the causes of accidents on city streets and national highways. We would have also studied the root cause of the problem—is it an issue of enforcement, or an issue of poor land markets that results in people on the street, or government contracting on building better and safer roads?

If governments are planning to spend crores on improving road safety, there is sure to be a strategy based on analysis of past car crashes. The government would estimate the costs of pursuing specific policy interventions and choose the few that give us the most bang for our buck. For example, what would it cost, and what management changes would it take to improve action against drunk driving? What is the process to ensure higher standards before a driving license is issued? What alternative techniques exist to build bends on the roads, or build road dividers that minimise the impact of a crash should it occur? How much do they cost? What changes—if any—are required in procurement policy?

This cost would then be evaluated against the savings that would be made by lowering the number of casualties. The answer would, of course, differ from location to location. We would then evaluate the success of the interventions before pouring more money into specific solutions.

The analysis that governments engage in—assuming they do—before making their decisions is not visible to their citizens. We are also rarely given information on which of the policy interventions worked, at what cost, and how would they scale. There seems to be some progress in Tamil Nadu, where road deaths fell from about 15,000 in 2014 to 10,000 in 2019. But little is known about strategic choices, policy interventions and their outcomes in other parts of the country. And hence, in a nutshell, we don’t truly know why we are a failure in road safety.

Way forward

Loss of life and limb is devastating to those who find themselves in such unfortunate events. There are larger economic ramifications too. Victims of road accidents are often the young, which leads to income shocks in households and a loss of productive human capital for the economy. A study by the World Bank shows that if India reduced road traffic mortality and injuries by 50 per cent and sustained it for a number of years, we would be able to generate an additional flow of income equal to 14 per cent of our GDP in 2014. Death and disability caused by road accidents are major contributors to poor health outcomes. Increasingly road safety is being seen as a component of international health policy. Prevention is better than cure. By focusing on road safety, we will see a greater impact on health outcomes, which is better than obsessing over health care alone.

Coming back to the Mistry car crash, the district administration in Maharashtra has said there were nine black spots on the Palghar stretch of the highway, and has suggested some short-term measures to provide warnings to slow down cars. The Union Minister for Transport and Highways has also admitted to the design of roads often being faulty and taking actions to improve the curves on the highways as well as identifying black spots. This is a start. A systematic collection of data and policy analysis will go a long way in implementing road safety.