|Image: Vikas Khot|
|Vikram Akula, Founder, SKS Microfinance|
SKS Microfinance, once a small not-for-profit — it had a mere 2,000 borrowers in 2001 — is now on the verge of becoming the first-ever micro finance institution (MFI) in India to go public.
The company is already a behemoth and is expected to overtake Mohammad Yunus’ Grameen Bank next year to become the world’s largest MFI with close to 8 million customers. Vikram Akula, founder and chairperson of SKS, tells Forbes India why at SKS there is no conflict between earning returns on equity for shareholders and creating sustainable livelihoods.
When you came back to India in 94-95, how did running the MFI programme for an NGO help you set up SKS later on?
I ran this MFI programme and what was wonderful about that is, first hand I got to see the tremendous impact that microfinance gets to make. I was basically managing a programme that was running in about 30 villages in Medak district in AP. Truly it’s a magical experience the way in which these women use the loans to transform their lives. Everything about it was a magical experience and I thought OK this is it, this is what I want to be doing. I did that for little over a year in the field. So what happened is one day, a woman from a more remote village — and this would happen to me quite often — would come and people would ask, ‘Can you start in our village?’
This particular incident with this woman actually changed my life, because when she came she was clearly quite poor and she had clearly walked quite a distance to get to where I was — emaciated, torn sari, just a bad situation and she basically said can you start this in my village? And I kind of knew the answer, but she was pleading so I said let me go back and ask at the office and they said look we don’t have funds to scale up. So I went back to this woman’s village and told her. She looked me in the eye and said am I not poor too?
And no one had asked me that question. And it really put me in my place, because here I was thinking I was doing something great, but what she made me realise is that if I’m only doing this in 30 villages, and I’m not doing it in a neighbouring village, effectively you are doing an injustice. It’s like if you have two children, you send one to school and hold the other one back. So I then left my NGO, went to the University of Chicago where I did my PhD and thought about her question, which is, how do you design microfinance in such a way that you never have to say no to any poor person who is simply asking for an opportunity?
What did you discover?
To understand what are the constraints in microfinance — why aren’t they scaling? And I identified three constraints, what I call the three Cs: Lack of access to capital — we were telling this woman we don’t have enough funds. The second thing we were telling this woman was we can only do this in x number of villages, we don’t have the ability to go beyond, so the capacity constraints. And then third, although not directly related to her question, was the high cost of doing microfinance. So I said OK, if those are the constraints, let me come up with a model that overcomes those constraints. And for me the answer was to use a commercial approach to overcome capital, use best practices from the business world to overcome capacity constraint — why is it that coke can scale, McDonald’s can scale but we can’t? And third, was use technology to overcome the cost constraints.
What lessons have you taken from Nobel prize winning, Mohammad Yunus’ Grameen Bank?
We’ve replicated the Grameen model. We’ve taken it and in terms of scaling, pushed it to a higher level by taking these three constraints and overcoming those. We didn’t have to invent the model of peer lending — that was pioneered by Grameen, and that was a critical innovation — because the first problem in lending to the poor is how do you give a collateral-free loan to a poor woman you don’t know, who has no credit history? To overcome that risk question, peer lending is a brilliant innovation. So we said, OK so the fundamental field level aspects of Grameen we don’t need to change. But the institutional, the system — capital, capacity, costs — that’s where I thought we could do something.
So I replicated the field level aspects, but really departed when it came to some of the institutional views. For example, let’s take the capital approach. Yunus believes that microfinance should be a social business, no profit no loss.
So we’ve got a very different view at SKS — our view is that we estimate the Indian market is something like Rs. 2.4 lakh crore on the debt side. Now if you need to raise Rs. 2.4 lakh crore, there’s no way you’re going to get that by saying social capital, no profit no loss. The only way you’re going to get that kind of money is by going to the commercial markets. And the way commercial investors look at microfinance, we would have to be not just profitable, we’d actually have to be extremely profitable. Because how do they look at it? Subprime, unsecured, lending to poor women who have no credit history. So we have to be more profitable than real estate, telecom and everybody else because of their perceived risk.
I’m making a social argument for as to why we should do that, I’m not saying anything about value monetisation. We have one goal, which is that poor woman I met many years ago, I can say yes, now you too can have an opportunity, how much do you need to start your business? So it is a commercial means, but fundamentally there is a social goal. That was the reason for founding SKS and that’s exactly what we do today.
Ten, eleven years ago how many bankers would have called to do business with me? It just didn’t happen. We’d have to go with a begging bowl. Today Forbes magazine comes to meet us — that shows this model has opened up the capital markets to the poor. That’s the fundamental difference between us and Grameen, and then if you say what’s changed, nothing at the core has changed. Because that impetus I had 11 or 12 years ago stays the same.
How do you maintain that social goal, that value addition for your customer when you’re growing at 200 percent? How do you carry that organisational culture across the country? And how do you do that when you also have to show financial profitability for your investors?
We don’t see conflict between the two. Fundamentally our organisation is about creating social value for our customers. I don’t even look at the profit lines. If you ask me the ratios ROE, ROA, I don’t know those things. It doesn’t matter to me what happens — what matters to me is that there’s social value. But I am confident that if we create social value, it will create financial value to our investors and this is the reason why. So first off, how do we create social value? In everything we do, we’re looking at the customers first. Does this work for the member, whether it’s a product, whether it’s a procedure, whether it’s a process?
We want our customers to be aware of the interest rates, the products and so on, and we spend a lot of time making sure they do so. Does that create financial value? No. The reason why we do that is because we want the customer to understand what’s happening and benefit from that process. So let’s take loan size for instance. Whether a customer takes a Rs. 2,000 loan or a Rs. 20,000 loan, [the] staff person gets the same financial compensation. Which means that his incentive is to say, ‘What does this woman need, and I’m going to do what’s right for her.’ And that’s how we create social value. Now our investors benefit from that in the following way:
The value for the investors is not the interest on the Rs 2,000 loan — that’s nothing. The value for the investors is when tomorrow she moves from 2 to 10 to 20 to 30 [thousand rupees] and stays with us — that’s when you create financial value. When she moves from one product to four products to five products. The value to the financial investor comes there. In order to create that later value to the investor, I need to have a customer who is extremely loyal to me. How do I make her loyal? By doing what’s right for her.
Regardless of the short-term profit or loss. For my financial investor I don’t say I’m creating social value, I say trust me, when she stays with us, you will earn financial value. That’s how the two come together. That’s why there’s no conflict. When Sequoia sits at the table with us or Sandstone sits at the table with us — they’re not saying raise the interest rates or raise the loan size, because they understand it’s not a short-term play, it’s a long-term play. That they will harvest greater profits in the future if we treat this customer right today.
If we don’t treat the customer right today, you undermine long term shareholder value. Every single investor understands that because we are in the fortunate position of being able to pick. There are some investors that don’t understand this, we just haven’t selected them.
A great WSJ article on myths behind microfinance and the viability of the business model in addressing sustainable and profitable methods in eleviating poverty and inclusive finance.
By SUYASH RAI and SONA VARMA
The power of finance to transform the lives of the poor is not well understood. Despite recent articles that raise concerns about microfinance, the evidence at large shows that successful microfinance institutions (and their list is growing) have managed to implement service delivery mechanisms that meet the needs of the poor, at a lower cost than most accessible alternatives. The work of these institutions, and a number of well-researched reports, shed light on the economic lives of the poor and the way the poor manage their finances.* These reports use detailed surveys, interviews and robust analytical techniques to improve our understanding of the impact of financial services on poverty.
Drawing on this body of evidence helps counter a number of popularly held misconceptions about role of finance in the lives of the poor. The following noteworthy misconceptions are worth highlighting:
The poor are not creditworthy: The recent financial crisis has given a bad name to ‘sub-prime’ borrowers in general, and often the terms ‘poor’ and ‘sub-prime’ are used interchangeably and equated with ‘lack of creditworthiness’. As research on the crisis is pouring in, we are learning that the real causes probably had more to do with the mechanisms of service provision and inadequate regulation. Moreover, the micro credit experience of the last three decades decisively challenges this perception, showing that if suitable mechanisms are used, the poor can be as creditworthy as the rich. The poor’s lack of collateral can be overcome with joint liability within a group of borrowers, and this has resulted in very high repayment rates in micro credit over the last three decades. Micro finance institutions have consistently reported repayments upwards of 95% in a number of developing countries.
Finance falls lower in the ‘hierarchy’ of needs for the poor, below health, education etc: Finance should ideally fall out of any such hierarchical ordering of ‘inputs’ into a household, because it is a cross-cutting tool that helps households’ wellbeing across several dimensions. For example, even someone living just on government support can benefit from a sound payment system that ensures timely delivery of cash or a savings facility that provides a safe option to save. Empirical research shows that the poor use many financial instruments frequently, but due to absence and unsuitability of formal mechanisms, they have to rely mainly on unreliable informal service providers.
Credit is the only financial service required by the poor: Most people equate financial service provision with the provision of credit. Studies clearly show that the poor need a range of services such as a) risk mitigation mechanisms, for example insurance, to protect against exogenous shocks; b) savings facilities to smooth consumption and get reasonable returns even on small amounts; and c) investment/risk management mechanisms that allow for wealth creation and diversification of risk. A number of successful initiatives, such as those providing micro insurance or small ticket investments in mutual funds, re-affirm the hypothesis that the poor demand and can benefit from the same wide range of financial services that are routinely provided for the rich.
“Given the complexity in their financial lives, the poor are very sophisticated in their use of financial instruments.”
The poor are not sophisticated in using financial services, so access to finance may end up damaging their livelihoods: On the contrary, research on the use of financial services by the poor shows that given the complexity in their financial lives, the poor are very sophisticated in their use of financial instruments. Due to the absence of well-designed formal services, they end up creating a complex mesh of informal financial mechanisms around their lives. It seems this is the only way they can meet multiple needs using informal instruments. For example, financial diaries of the poor show how they creatively use a variety of loan sources to deal with the irregularity in their incomes and expenditures. Research also shows quite convincingly that on an average the chronic poor, i.e. those who fail to move out of poverty, do take initiatives to change their conditions. Failure to move out of poverty is primarily because of lack of access to capital and relevant networks. The recent evaluation of a micro credit program in India shows how entrepreneurial households consistently use credit to start successful new businesses or improve the profitability of existing businesses.
Finance can help poor households optimize severely constrained resources across their lifetime. Like the rich, the poor also need to use finance responsibly to ensure that they avoid over-indebtedness and other problematic outcomes. Similarly, financial service providers need to focus on reducing delivery costs while ensuring high quality services that reflect a good understanding of client needs. This often ups the ante in terms of the work that goes into offering a useful suite of financial services for the poor. But the rewards can be immense.
* A report by the World Bank titled “Moving out of Poverty” presents results of research on the processes of falling into and coming out of poverty. Similarly, “Portfolios of the Poor: How the world’s poor live on $2 a day”, a book by leading researchers in the area of access to finance, presents analysis of households’ financial behaviors in three developing countries, documented using rigorous methodologies. A recent paper from researchers at MIT presents the results of evaluation of a microfinance operation in Hyderabad, India, the first ever randomised evaluation of micro credit
—Suyash Rai is Senior Manager and Sona Varma is Senior Advisor with IFMR Trust, a private trust with the mission of ensuring complete access to financial services for individuals and enterprises in India.