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Microfinance Shows Strong Equity Valuations Despite Crisis

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WASHINGTON, March 3 /PRNewswire-USNewswire/ — Sustained demand for microfinance equity, in the face of the worst financial crisis in decades, continued to propel valuations in this sector higher throughout 2009 and the medium-term outlook remains positive, according to a new report by CGAP, a microfinance group based at the World Bank, and J.P. Morgan.
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“Microfinance institutions encountered the harshest market conditions in more than a decade during 2009, with most showing a clear deterioration in asset quality and profitability,” said Xavier Reille of CGAP, co-author of the report. “And yet most MFIs continued to maintain strong reserve and capitalization levels, and investors continued to show faith in the sector.”
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The CGAP/J.P. Morgan report shows that equity valuations continued to rise across all regions in 2009, with MFIs in the private equity market trading at a median of 2.1 times book value – a 62 percent increase since 2007. Public investors significantly increased their commitments to microfinance last year, and the private sector continued to establish new microfinance equity vehicles, including new funds from Blue Orchard, Triodos, and Developing World Markets.
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“The investor community, both public and private, continues to be interested in microfinance, though we think that they are becoming more selective,” said Nick O’Donohoe, Global Head of Research for J.P. Morgan and co-author of the report.
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The relative youth of the microfinance equity market means there are few established performance benchmarks, making assessments difficult. However, the CGAP/J.P. Morgan report is bridging this gap by drawing on analysis of 200 private equity transactions between 2005 and 2009 and trading information on eight publicly-listed low-income financial institutions to assess the strong performance of the microfinance equity market.
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Indian MFIs are continuing to attract the strongest investor interest, comprising 30% of all microfinance equity transactions in 2009. Indeed, equity valuations for Indian MFIs are trading at nearly six times their book value, or three times the global median, a performance the CGAP/J.P. Morgan analysis suggests is not sustainable over the longer term.
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The strength of MFI equity valuations masks the impact of the global financial crisis on the sector. The CGAP/J.P. Morgan report shows that loan portfolio quality began to deteriorate rapidly after January 2009, with past due loans over 30 days jumping to a median of 4.7 percent from 2.2 percent over the first five months of 2009 although it has moderated since then and thus far remained stable in 2010. The effects of the downturn were far from uniform however, with MFIs in South Asia and South America showing few signs of impact, while others in Eastern Europe and Central Asia particularly were more affected. However, very few MFI failures have been reported and most institutions remain well capitalized with equity ratio unchanged in the 18 to 20% range.
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Judging by the performance of listed low-income financial institutions, the most comparable listed vehicles to MFIs, investors believe the sector will emerge from the crisis in good shape. These stocks have strongly outperformed emerging market banks (as measured by the MSCI Emerging Markets Bank Index) and by the end of 2009, had rebounded to pre-crisis levels or new historical peaks.
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The CGAP/J.P. Morgan report argues that the decline in asset quality at MFIs will likely slow, but not curb, growth in their asset base, while placing a focus on improved risk management. Valuations likely will continue to be underpinned by continuing public and commercial sector demand in the medium-term, further buoyed by local bank acquisitions of MFIs and an expected initial public offering by SKS, India’s largest MFI – in 2010.
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About CGAP
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CGAP (The Consultative Group to Assist the Poor) is the world’s leading resource for the advancement of microfinance. CGAP provides the financial industry, governments and investors with objective information, expert opinion, and innovative solutions to effectively expand access to finance for poor people around the world. More information:  www.cgap.org
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About J.P. Morgan
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J.P. Morgan is the investment banking arm of JPMorgan Chase & Co. (NYSE: JPM), a leading global financial services firm with assets of $2.0 trillion and operations in more than 60 countries. JPMorgan Chase is a leader in investment banking, financial services for consumers, small business and commercial banking, financial transaction processing, asset management and private equity. The firm serves millions of consumers in the United States and many of the world’s most prominent corporate, institutional and government clients under its J.P. Morgan and Chase brands. Information about J.P. Morgan is available at www.jpmorgan.com.
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In this paper, the authors, Karel Janda and Barbora Svárovská, first introduce microfinance institutions as an alternative investment instrument. They argue (convincingly) that beside socially responsible features of microfinance, there exists also significant portfolio enhancement opportunity in microfinance investments. Then they provide an overview of possible ways how to evaluate the correlation between microfinance related financial instruments and conventional financial market measures of risk and return.

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This paper is available for download at: http://mpra.ub.uni-muenchen.de/19486/1/MPRA_paper_19486.pdf

Sparking a Savings Revolution

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There’s an old saying about poverty: Give me a fish, and I’ll eat for a day. Give me a fishing rod, and I’ll eat for a lifetime.

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There are many variations in that theme. In Somalia, I heard a darker version: If I buy food, I’ll eat for a day. If I buy a gun, I’ll eat every day.

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But these days, there’s evidence that one of the most effective tools to fight global poverty may be neither a fishing rod nor a gun, but a savings accounts. What we need is a savings revolution.

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Right now, the world’s poor almost never have access to a bank account. Cash sits around and gets spent — and, frankly, often spent badly.
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“We used to buy a three-liter bottle of Coke every day,” recalled Socorro Machado, a 49-year-old homemaker in a village here in northwestern Nicaragua. That was a bit less than a gallon, and the cost of $1.75 consumed a large share of the family’s budget.
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Then Catholic Relief Services, an aid organization, arrived in the village with a new program to promote savings. It provided a wooden box with a padlock and organized savings groups of about 20 people who meet once or twice a month, typically bringing 50 cents or $1 to deposit in the box.
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Some of the money is lent out to start a small business, but the greatest benefit of these programs seems to be that they provide a spur to save.
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“Now we buy a bottle of Coke just once a week, and we put the money in savings,” Ms. Machado said. She saves about $5 a month in her own name and another $5 a month in her son’s name and has plans to buy a computer for him eventually.
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Some people in the development world argue that microlending has been oversold, and there has been a bit of a backlash against it lately — including a “no pago” movement here in Nicaragua. This “don’t pay” effort has been orchestrated by the leftist government of President Daniel Ortega.
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I don’t agree with the criticisms of microloans, for I’ve seen how tiny loans can truly transform people’s lives by giving them the means to start small businesses. Even so, there’s evidence that the most powerful element of microfinance is microsavings, not microloans.
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One of the ugly secrets of global poverty is that a good deal of suffering is caused not only by low incomes but also by bad spending decisions. Research suggests that the world’s poorest families (typically the men in those families) spend about 20 percent of their incomes on a combination of alcohol, cigarettes, prostitution, soft drinks and extravagant festivals.
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In one village here in Nicaragua where children were having to drop out of elementary school because they couldn’t afford notebooks, a midwife, Andrea Machado Garcia, estimated to me that if a man earned $150 working in the mountains as a day laborer during the coffee harvest, he might spend $50 on alcohol and women and bring back $100 to support his family.
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One challenge is that those men don’t have a good, secure way to save money, and neither do poor people generally. It just sits around, itching to be spent. It’s also vulnerable to theft, covetous family members and demands for loans from relatives.
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In West Africa, money collectors called susus operate informal banks but charge an annualized rate of 40 percent on deposits. Yes, you read that right. You pay a 40 percent interest rate on your savings!
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In Kenya, two economists conducted an experiment by paying the fees to open bank accounts for small peddlers. They found that the peddlers who took up the accounts, especially women, enjoyed remarkable gains. Within six months, they were investing 40 percent more in their businesses, typically by buying more goods to be resold.
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Many aid groups including CARE and Oxfam now offer savings programs in some form, and the Bill and Melinda Gates Foundation is studying how best to promote financial services for the poor. A Web site, www.matchsavings.org, lets donors match a poor person’s savings to increase the incentive to build a savings habit.
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So it’s time for a global microsavings movement. Poor countries should ease the regulations (such as requirements for banking licenses) that make it hard for nonprofits to operate microsavings programs.
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Hugh Aprile, a Catholic Relief Services official here, noted that savings schemes are very cheap to start because no capital is used to provide loans. “It’s people using their own money,” he said, “to build far more than they ever thought they could.”
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Maybe it’s hard for us to believe considering how much animus there is toward fat-cat bankers in the United States, but the world’s poor might benefit hugely from the ability to bank their money safely.
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We read this recently from ProCredit’s website and agree with their sentiments and approach. We do not want to minimize nor exaggerate the social impact of microfinance, but want to use it for what it can do best calling upon other approaches and parties to bring their efforts to bear toward poverty alleviation.

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Microfinance and our expectations

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Microfinance has gained an increasingly high profile; the UN’s “International Year of Microcredit” in 2005 and the Nobel Peace Prize awarded to Mohammad Yunus in 2006 attracted considerable media attention. ProCredit Holding consciously chose to make few appearances at the activities surrounding these events. We found the claims and hype regarding what microfinance can achieve to be excessive.

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In principle, we welcome efforts to highlight the challenges and opportunities faced by neglected target groups. We fear, however, that the importance attached to microfinance – presented as the cure-all to eliminate poverty – will raise expectations that cannot be fulfilled. If these expectations are disappointed, the public may be disillusioned and lose interest.

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In contrast to this mostly short-lived rash of activity, we focus on building stable institutions that make vital contributions to building the financial sectors of the countries in which we operate. This long-term orientation calls for patience, tenacity and moderate expectations based on realism.
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Microfinance is hardly the solution to problems of abject poverty. However, a functioning and inclusive financial system makes a contribution to a country’s development. Stimulating and accelerating such processes takes time. It requires stable institutions whose owners take a long-term view and whose staff are well-trained and can win customers’ trust. This is precisely the focus of our efforts.
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Helping the poor just got popular

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By Sophia Grene,  Published: November 8 2009, Financial Times

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Since Muhammad Yunus won the Nobel prize in 2006 along with the Grameen Bank he founded for the poverty-bound entrepreneurs of Bangladesh, microfinance has entered the consciousness of the investment community.

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The concept of lending small amounts to very poor women, each borrower part of a group that is jointly responsible for repayment, has been extended and modified as it moved to different economies with other requirements. The common thread is providing relatively small loans to people who would otherwise not have banking facilities.

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While the original concept was all about lending a helping hand to lift people out of poverty, the inevitable result of the structure was that investors would see it as an opportunity.

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Grameen Bank itself cannot look for investment from outside Bangladesh for legal reasons, but a myriad of other microfinance institutions are not so bound and globally some $7bn (£4.2bn, €4.7bn) is invested in MFIs. An equivalent amount is committed by donation, but the invested money is expected to be repaid with interest.

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More than half of this money is from development finance institutions – state-led banks with a mandate to focus on poverty alleviation – but the rest comes from the private sector, institutional and retail investors hoping to get a return on their money.

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Triodos Investment Management has a retail fund with a track record going back six years, giving investors an annual return between 6 and 9 per cent. Last year, with the global financial system collapsing round our ears, the fund returned 7.5 per cent.

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This lack of correlation with the rest of the financial world is one reason for investors to put their money into microfinance, but it seems not to be the main one.

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“For retail investors, it’s the social aspect – in general they are not looking for the highest financial return,” says Marilou van Golstein Brouwers, managing director of Triodos Investment Management.

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“Institutional investors have to care more about return because of their fiduciary duties, but they are increasingly looking to invest some or all of their portfolios responsibly.”

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Asad Mahmood, who runs a social investment unit at Deutsche Bank, agrees. “You have to understand the duality of purpose. It is not a philanthropic effort, but nor is it wholly commercial. It is a new hybrid,” he says. Institutional investors, he suggests, come to the asset class with an enthusiasm for doing good, enabled to do so while fulfilling their fiduciary duty by the potential returns.

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Those returns are not all as straightforward as those of the Triodos fund. Mr Mahmood says he is just about to close a fund with several layers of debt- holders. The interest on senior debt – which gets paid out first – is 7 per cent, not to be sniffed at in the prevailing low interest rate environment. Investors prepared to take more risk can opt for a tranche of the investment paying 16 per cent, provided the underlying loan portfolio has a sufficient yield. This seems like a substantial profit to make out of lending to the poor, and Mr Mahmood is conscious of the dangers.

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“If you are providing financing to the poor and your only motivation is maximising profit, pretty soon there will be abuse.” He cites examples like the subprime mortgage brokers who foisted unaffordable mortgages on house buyers to generate commission for themselves.

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“As the industry grows, you will have differently motivated investors coming in. Some people will be interested in the low correlation, which is fine, but I don’t want people who are solely concerned with profit maximising to come in.”

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Nevertheless, pension funds have committed about $3bn to the asset class, according to a recent report from the World Microfinance Forum. Dutch pension funds PGGM and ABP have led the way with allocations of €200m and €180m respectively.

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The global financial crisis has not had a huge impact on the levels of investment in microfinance, according to research from Intellecap that appeared in specialist magazine Microfinance Insight earlier this year. What has changed is the form of the investment.

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Private equity microfinance investment is a growing sector. When global liquidity dried up, “the spread for debt financing was incredible”, says Mr Mahmood. “Equity financing was easier to raise.” According to further research from Intellecap, private equity investors have seen recent developments as much in the light of an opportunity in microfinance as a problem. Low valuations of the existing institutions and the low correlation of returns on microfinance with the global economic system make it an attractive proposition.

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Triodos’s fund is one-third equity, with the rest in debt.

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Microfinance is not immune to criticism. For many, it has strayed too far from Mr Yunus’s original idea of social lending; many microfinance institutions in eastern Europe and Latin America lend to established businesses, becoming essentially indistinguishable from traditional banks in the small and medium-sized enterprise sector.

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Others are uncomfortable with the idea of charging what can seem like punitively high interest rates to poor borrowers – microfinance is resource-intensive as lending has to be informed by detailed understanding of borrowers’ ability to pay in relatively informal economies.

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Still others see it as simply too small to make a difference – less than $15bn of capital globally is not going to change the world. But for investors who want to do something socially useful with their money, it looks set to remain an attractive option.

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Copyright The Financial Times Limited 2009.

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The Berlin Wall of Aid: When Will It Fall?

Top-down economic development in Africa hasn’t worked. Here’s an alternative.

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By GLENN HUBBARD, Wall Street Journal – November 9, 2009

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On November 9, Germany and the world will celebrate the 20th anniversary of the fall of the Berlin Wall. The fall marked the end of Eastern Europe’s failed system of state-run economic development. But systems of top-down economic development continue in most of the poor countries of the world, where aid donors continue to fund government development projects despite their decades of failure. Why is this so? Why has the “Berlin Wall of Aid” not fallen despite its record of failure?

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The answer is simple: the Soviet Union controlled the system throughout Eastern Europe. Once Mikhail Gorbachev decided to stop supporting the system by force, it crumbled. In poor countries today, the system is fragmented among dozens of unconnected national governments and dozens of unconnected aid donors. There is no Gorbachev to pull the plug. So the failing aid system continues, and unfortunately, there is no obvious remedy on the horizon.

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The failure is not hard to diagnose. Prosperous countries developed their wealth through the growth of a domestic business sector. India and China are only the most recent examples. A thriving local business sector is the only path to prosperity and business the world has ever known.

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Let’s look at the World Bank’s Doing Business report, which ranks countries by how easy it is for local citizens to start and run businesses. Among 183 countries, the former Soviet Union make up 20 in the top half and only eight in the bottom half. Georgia is highest at 11 and Tajikistan is lowest at 152. From sub-Saharan Africa, only six countries are in the top half while 38 are in the bottom half. Mauritius is highest at 17, and the Central African Republic is lowest at 183. The former Soviet bloc has come a long way in its shift from government economic development to the local business sector. But Africa has much, much further to go.

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There have been three recent calls to tear down Africa’s aid wall: George Ayittey’s Africa Unchained, William Easterly’s White Man’s Burden, and Dambisa Moyo’s Dead Aid. Many observers agree with them, but these calls fall mostly on deaf ears among the people in power: the heads of aid agencies and the leaders of poor countries. It is in the interest of many of them for aid to continue. In our recent book “The Aid Trap: Hard Truths About Ending Poverty,” my colleague William Duggan and I suggest an alternative. Instead of halting aid, we can shift much of it from government-directed projects to the local business sector. And we have a compelling precedent — the Marshall Plan of post-war Europe. It made loans to local businesses, which paid them back to their local governments, who then used the money for commercial infrastructure to help those same businesses.

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The world recognizes the Marshall Plan as the most successful aid program in history. We find smaller versions in post-war Japan, South Korea and Taiwan, and in Eastern Europe – as Enterprise Funds – after the fall of the Wall. But the central mechanism of the Marshall Plan can adapt to any kind of economy. Post-war Greece was small, war-torn and very poor–in some respects like most of Africa today–and the Marshall Plan in Greece was a great success.

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Can the aid system shift, or is it too inflexible – like the Soviet system was – to adapt to a new Marshall Plan? We can find some encouragement in two changes in the aid system over the past two decades: it has accommodated NGO projects and microfinance alongside government programs. Humanitarian aid especially works best through NGOs, and microfinance has helped millions of poor people start and run micro-businesses across the world. These major shifts over the past two decades show that the aid system has some ability to adapt beyond its traditional form of government development projects.

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But NGOs can’t raise people out of poverty — only local business can do that. And microfinance operates in most poor countries below the radar with unregistered companies that can’t get formal loans or join the normal business sector. Small and medium-sized businesses, not microfinance, generate the jobs and demand that lift poor countries out of poverty. That’s how it happened in Western Europe, the United States, East Asia and now China and Eastern Europe.

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A Marshall Plan would continue aid to poor countries, but directs it in a way that can actually lead to prosperity. The growth of NGOs and microfinance show that the aid system can adapt. But the shift to local business will be harder, because it is a more fundamental change of the economic system. NGOs and microfinance can operate alongside government development projects while local businesses are a direct alternative to them.

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The Marshall Plan might not be the only way to shift large amounts of aid to the local business sector in poor countries. If there is an easier or faster way, all the better. But the time has come for the Berlin Wall of aid to fall. Sub-Saharan Africa is as poor today as it was 50 years ago despite increases in foreign aid.

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The Berlin Wall lasted only 28 years, from 1961 to 1989. How long will the aid wall last? Who will tear it down?

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Mr. Hubbard, dean of Columbia Business School, was chairman of the U.S. Council of Economic Advisers from 2001 to 2003. He and William Duggan are co-authors of “The Aid Trap: Hard Truths About Ending Poverty” (Columbia, 2009).

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Microfinance Mission Drift?

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By Roy Mersland and R. Øystein Strøm, published by Elsevier Ltd, July 2009

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This paper studies the tendency of microfinance institutions (MFIs), as they grow, to cater to groups that are different from those normally considered to fall under the “mission” of microfinance. Generally, this mission includes serving low-income people who have less access to credit – often poor, rural women. To investigate this possible mission drift, loan size, lending methodology and gender bias were studied in 379 MFIs in 74 countries using data taken over 4 to 6 years. Average loan size did not increase from 1999 to 2007.

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There has not been a move from group-liability to individual-liability loans. Nor has there been an increased proportion of urban loans compared to rural loans. However, there is less gender bias now, meaning that the tendency to lend to females more than to males has decreased. Overall, the authors feel that there has not been a mission drift in microfinance.

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The average loan size from 1999 to 2007 was USD 747, adjusted for purchasing power parity (PPP). The authors consider this to be a relatively small loan size. Furthermore, the average loan size has decreased by 2.2 percent from 1999 to 2007. This is seen by the authors as evidence that low-income borrowers are still being targeted by MFIs. Lending methodology was measured to compare group and individual lending. The authors found that most loans are made to individuals.

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However, group lending increased by 3.3 percent during this period compared to individual lending. The authors view this as a sign that microfinance continues to meet its mission. It has also been tradition that MFIs would target rural regions more than cities as the former are generally thought to have less access to mainstream credit. The authors found that rural lending grew by 9.5 percent from 1999 to 2007 compared to urban lending.

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Lastly, the authors find that there has been a decrease of 35 percent from 1999 to 2007 in terms of preference for female clients. Though this may seem inconsistent with the microfinance “mission,” it does indicate less gender bias. Therefore, the authors do not see this result as particularly harmful and claim that it does not necessarily indicate mission drift.

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By KETAKI GOKHALE

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NEW DELHI — Despite last year’s global financial meltdown, the microfinance industry has continued to boom in India because of an influx of private equity and bank funding, according to a new study.

Microlenders recorded a 60% increase in clients in India, to 22.6 million in the year ended March 31, 2009, from 14.1 million the previous year, according to a report from Access Development Services, a New Delhi-based nonprofit serving the microfinance industry. Microlenders lend small amounts of money to groups of poor people, mainly to help foster entrepreneurship and trade.

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In contrast, the formal banking system in India recorded 15% growth over the same period in the number of poor and underserved clients it serves, expanding its reach to 54 million clients from 47.1 million clients, according to the study. For the last 15 years, the formal banking system has been partnering with nongovernmental organizations to deliver loans to people living below the poverty line (around 20,000 rupees a year, or $430) and people who live in remote areas.

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At the current growth rate and with larger loan sizes, microlenders might outstrip the formal banking sector in lending volumes within a few years, said N. Srinivasan, the author of the study.

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The surge in microloans has been fueled by a brisk flow of funds in the third quarter of this year, with about $130 million in global private-equity funds funneled into Indian microfinance institutions, according to the Center for Microfinance in Chennai.

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“In the middle of last year, we thought for a while the meltdown would strike this sector, but we’ve seen that it’s been largely unscathed,” said Vipin Sharma, chief executive of Access Development Services. “Growth is as frenetic as it was before.”

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Mainstream banks, in both the private and public sectors, are increasingly considering channeling funds into microfinance banks rather than directly to India’s poor. Four public-sector banks and three private-sector banks entered microfinance this year, making for a total of roughly 30 banks invested in Indian microfinance. Total bank funding for microlenders nearly doubled to $2.526 billion from $1.281 billion in the year ended March 31 from the previous year.

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Some foreign banks have reduced their exposure to microfinance in response to the global economic downturn and less liquidity, and smaller regional microlenders are having a hard time accessing bank funds because of a recent loan repayment revolt in the southern state of Karnataka, Mr. Srinivasan said. Borrowers in two rural districts stopped repaying their loans en masse at the urging of local religious authorities who felt that microfinance had taken too strong of a hold in their community.

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But several state banks and major Indian lenders stepped in to fill the gaps. At the same time, a number of major microlenders have pooled 28 million rupees to form Alpha Microfinance Consultants, which will set up a credit bureau to reassure investors and to prevent future repayment crises like the one seen in Karnataka.

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Printed in The Wall Street Journal, page C6

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Copyright The Financial Times Limited 2009.

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.