Mint, 21 August 2013

Cure the disease, don't kill patients

Imposing restrictions on business is not an optimal approach to design regulation for consumer protection

Whether it is the current crisis at the National Spot Exchange Ltd (NSEL) or the Saradha scandal a few months ago, violations of consumer rights, and the resolution of such transgressions continue to befuddle us. The response, all too often, has been to impose restrictions on business and, sometimes, ban the sale of the product, or prohibit operations by the larger set of firms that may have nothing to do with the problem.

It is important to ask if this is an optimal approach to design regulation for consumer protection. While there may be benefits of such an approach, the costs are almost always never measured. Often regulation of this nature causes more damage to the very people it was designed to protect. One example of such an extreme measure in the name of customer protection is the ordinance on microfinance passed by the Andhra Pradesh government in October 2010. The ordinance was a reaction to suicides in Andhra Pradesh which were allegedly the result of harassment and coercion on loan repayment by microfinance institutions (MFIs). The ordinance made it extremely difficult for MFIs to generate new loans or collect repayments, leading to large-scale defaults. Since then, the microfinance industry in Andhra Pradesh has been at a standstill.

Critics of MFIs may applaud their demise in the state. However, the disruption caused by such an abrupt ban may have enormous consequences. Recent research finds that average consumption expenditure of households in the Andhra Pradesh regions decreased by 19.5% as a consequence of the ban, with sharper drops in food consumption and expenditure on education. Other field studies have also found a dramatic fall in expenditures of households impacted by the ordinance.

While the ban on microfinance was initiated by policymakers in Andhra Pradesh under the claim that this would help poor people, it seems to have done the opposite. This raises questions on the nature of the regulatory response, as well as the process through which such an action was taken. The response of the regulators was to allege coercive practices of a few MFIs. The ordinance led to the closure of the entire industry. The process was swift and sudden, with no possibility for the accused to present their case. The government which took the action was itself a competitor to the MFIs with its own self-help group programme, and therefore, not a neutral third-party.

Could the issue have been handled differently? Ideally, the charges of physical harassment, the key allegation against MFIs, should have been investigated by the police, which should then have intervened to protect those being hurt. It is possible that several MFIs were guilty of coercive practices, in which case action should have been taken against them. The issue of non-repayment (or such financial matter) should have been filed in consumer courts. Ideally, a swift due process would have been followed and action taken as per the merits of the case.

One problem in India is that consumer protection laws are not clearly defined so that on several issues, it is hard to precisely point out the guilt. The bigger problem is that we do not believe that people, especially the poor, can meaningfully seek recourse from the police and courts. This fundamental distrust of institutions leads us to extreme preventative measures such as the AP ordinance. Because our institutions do not work, we decide the industry should also not work, or work very slowly.

How may we change this status quo? The first task would be to clearly identify the rights and obligations of consumers and service providers. Take the example of microfinance once again, which is carried out in India under the joint-liability framework. Here, the role of the group is unique. Careful analysis and clarity is required, of the rights of borrowers vis-a-vis the MFI, the rights of the group against the MFI and the rights of the individual against the group. If we believe that finance is complex, and customers, especially the poor, are more vulnerable to mis-selling and other coercive practices, then we need to demand greater care by financial service providers in servicing them. The laws need to specify the principles that the service provider must meet instead of dictating how it should carry out its business.

Once the laws are set up, we need to build a system which can be accessed by everyone for complaints against misdemeanours of service providers, while also giving the latter a fair hearing, within a specified time frame. There needs to be a freeze on that particular transaction while the hearing is in process. All of this is best done with one front-end for the customer such that all formal, semi-formal and dispersed suppliers of finance such as MFIs are brought under the scanner of consumer protection law.

Ultimately, finding ways around poor laws and poor enforcement, with bans, or other preventative regulatory measures will only get us so far, and sometimes just take us two steps back. Not fixing laws and the enforcement machinery is not an option.

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