Banking Central | Time for RBI, industry to look deep into corporate governance issues in NBFC-MFIs

Indian microfinance institutions (MFIs) faced an unprecedented crisis in 2010 when the Andhra Pradesh government came out with a “draconian” law after several borrowers died by suicide due to coercive collection practices and usurious lending rates.

It was a watershed moment that altered the industry’s composition and changed the way microlenders operated. Several old-generation microlenders perished. Those who survived had to comply with tighter regulation of interest rates, collection practices and agree to broader principles of corporate governance.

Subsequently, a new category of microlenders—NBFC-MFIs— was created. A decade after the crisis, the MFI industry is much better regulated, with improved corporate governance. Some of the old generation MFIs like Bandhan and Ujjivan have evolved into banks. SKS Microfinance (Bharat Financial) merged into IndusInd Bank. A new industry order is in place now.

But some reminders of the governance issues of the past keep popping up. Last week, the fraud reported in Odisha-based Sambandh Finserve, a mid-sized firm, shows it is time for microlenders and the regulators to pay closer attention to corporate governance.

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 The charges

The accusations made by key management personnel in a letter to the board are serious.

The letter says the actual portfolio as assets under management (AUM) of the company is approximately Rs 140 crore as against the reported figure of Rs 391 crore as on September 30, 2020. This means reported AUM is inflated and non-existent. The gap, approximately of Rs 251 crore, in the portfolio was allegedly managed by fictitious disbursements, subsequent withdrawals and deposited as fictitious collections on the directions of MD & CEO Deepak Kindo, who is believed to have kept saying “it would be managed”.

The fraud came to light after Brickwork Rating cut the rating on a range of Sambandh’s debt instruments to junk as the firm faced a severe liquidity crunch and defaulted on payments.

The fudging had been going on since the financial year 2015-16. The letter raises serious doubts about the role of Kindo, including accusing him of diversion of funds. The irregularities were committed on the instructions of the CEO, who also withdrew cash to divert to other entities and other unknown persons or entities.

The CFO and other signatories of the letter have said the fraudulent transactions were committed under the “express instructions and directions” of Kindo. The board chairman is a family member of the CEO.

 Time to up the guard

Sambandh is registered as an NBFC-MFI. This means it is governed by the Reserve Bank of India (RBI) regulations. Around 34 lending institutions, including commercial banks and NBFCs, have exposure to Sambandh. These include Canara Bank, ICICI Bank, MAS Financial Services, Hinduja Leyland Finance, Northern ARC Capital and SIDBI. According to industry officials, some of the microlenders still have weak corporate governance practices which, if left unchecked, could escalate into yet another industry issue.

The Sambandh episode should be not seen in isolation. This should be an eye-opener for the regulator and the industry to tie up the loose ends in corporate governance and self-regulation.

SROs of major industry lobbies, MFIN and S-Dhan, have already looked into the issue and are waiting for the outcome of a forensic audit of Sambandh’s accounts. The nature of the fraud doesn’t rule out the possibility of similar events in other MFIs.

The industry will do well to set stricter rules on accounting and reporting of financials and beef up fraud detection tools in such companies.

There are serious questions that remain unanswered. If the fraud was happening for the last four years, why couldn’t the auditors flag this to the regulator? What were independent directors doing?

Sambandh is a fit case for the RBI to take a closer look and examine the loose ends in the NBFC-MFI regulation. One bad apple can spoil the whole barrel.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)