Professor C.K.Prahlad, of the University of Michigan and an IIMA alumnus introduced the idea of tapping into the fortune at the “bottom of the pyramid” by providing value, in terms of product and services, to the poor. However, business models based on financial services for the poor are a recent development, and have faced significant challenges.
The global microfinance industry is based on the principle of financial inclusion- to let people who have very limited access to lending avail of the benefits of timely capital. Commercial banks often face transaction costs that far outweigh the commissions earned by servicing the accounts of poor and needy people. This has given rise to the establishment of a separate set of lending institutions dedicated solely to the poor. The unsteady income of many of the borrowers, coupled with the lack of collateral, is the primary reason why microfinance institutions often charge high interest rates, which has been quoted as a cause of concern in the news. Microfinance institutions do reduce the risks they face through the practice of solidarity lending in which groups of borrowers in the community are made collectively responsible for repayment of loans of each member of the group. However this reduced cost of lending is still around 20% to 40%, which is usually charged by these institutions in India, and is much lower than the rates charged by local moneylenders, which are, on average, around 100%, and can go up to 500%.
Regulatory and Political Risks and Moral Considerations
Recently India-based SKS microfinance has been widely reported in the news for being a colossal failure in the MFI industry. SKS was funded by Bajaj Allianz and later raised Rs. 75b (the largest ever, for an MFI) through equity investment. While SKS charged rates of 26-34%, it nevertheless incurred a loss of Rs. 1360 crore in 2011, and an equally large amount of private debt. However, it should be noted that this loss can be attributed to politically motivated intervention and interference in the industry following suicides amongst borrowers. Although India does have a problem of farmer suicides, and the borrowers in question did have larger outstanding loans at higher interest rates from moneylenders, the suicides wer attributed to the MFIs. Calls from politicians encouraging borrowers to default on Microfinance loans lead to recovery rates plummeting from close to 100% to around 20%. SKS Microfinance also had to ground staffers following arrests of its field workers.
Another take on the issue of profitability and high interest rates is provided by Mohammed Yunus, the founder of Grameen Bank, the world’s most renowned microfinance institution, who claims that agencies should not be charging more than 15% of their long term operating costs as the interest rate. Dr. Yunus had also expressed his dissatisfaction towards SKS for raising an IPO. According to him this was a signal to investors indicating prospective profits at the bottom of the pyramid, which he believes is undesirable. However, SKS’ case remains moot- in Bangladesh, Grameen Bank could obtain deposits to fund its operations but that same activity is not possible in India due to a restriction on banking licenses. Thus, most of SKS’ deposits originate from commercial capital markets. However, with the new Microfinance Institution (Development & Regulatory) Act on the anvil, MFIs would not have to register themselves as lending institutions, taking them directly under the purview of the RBI and outside the jurisdiction of local anti-usury laws.
Shifting the perspective to online lending, global MFI portals such as Kiva Microfunds have demonstrated stable profitability over the years. Closer home, founded in 2010, peer-to-peer foundation Milaap is the first online lending platform designed for NRIs and non-Indians make loans to the poor. Based in Singapore & Bangalore, Milaap allows lenders to browse through a list of borrower profiles and their specific needs and then select their preferred borrower. Disbursement and repayments are done via field partners and Milaap also claims a repayment rate of 100%. The interest rate charged in 12-18% which is half the available microlending rate in the market. So far, Milaap has raised $200,000 from Atlanta based First Light Ventures and $40,000 from Spring Singapore, besides getting various Singapore based VCs to pitch in $1-1.2m in July 2012. As illustrated by these reports, the business model of online lending is one of the most promising solutions for the MFI sector and probably we shall see ever more development in that direction worldwide.
Shift back to Individual Financing
According to a report published by the Microfinance Information Exchange for the Latin American & Caribbean region, while debtors grew at an annual rate of 17% between 2006 & 2011, creditors grew at 24%. Meanwhile the gross loan portfolio rose at 23% per year to $15.8b. This shows a clear profitability trend emerging in South American nations, where microfinance penetration is the deepest and businesses have successfully implemented models based on solidarity lending, joint liability and local lending networks. However joint liability models have the potential to promote moral hazard and a hesitance towards taking responsibility among the debtors. Moving away from joint liability, several lenders have started using individual credit contracts, repayment schedules, subject monitoring and non-refinancing threats, which have made individual financing a more viable option. Brazil’s Banco do Nordeste, which has one of the most sophisticated microlending platforms, the CrediAmigo, has targeted individual urban microentrepreneurs and had achieved both stable profitability as well as low risk portfolio risk. The urban segment usually involves better business sense on the debtor’s part and a greater probability that the business launched with the help of the microfunding would actually be both liquid as well as sustainable in the long run.
Microfinance across the world
Recently, Forbes launched the rankings of the 50 best microfinance providers in the world by comparing them on categories like gross loan portfolio, %loans overdue by more than 30 days, operating expenses per active borrower and return on assets and these parameters were graded on scale, efficiency, risk & returns. Although Indian and Bangladeshi firms were prominent in the list (9 & 8 entries respectively), among the best managed were also 3 Moroccan & 3 Colombian microfinance funds. The Moroccan govt. has secured $46m in funds for better internal control over MFIs. Political instability in the region has greatly compromised MFI’s ability to operate and more and more number of loans had to be extended in 2011-12. However again, whatever profitability that the MFIs could salvage existed due to the group liability model.
Asia remains microfinance’s largest market with 74m borrowers in 2011, and 37m deposit accounts. While $15b has been mobilized by depositors, there are $34b worth of loans outstanding, primarily from India and Bangladesh. The return on assets ratio has hovered around 3% in the last 5 years but with the downside that portfolio risk has shot up 5-fold. On the other hand in North Africa and the Middle East, outreach and scale are extremely low with loan balances being just 16% of per capita GNI. Corporates & SMEs compose only 5% of the total portfolio. Operating expenses are low, but this is attributed more to the inability to secure funding rather than funding at low cost, leading to RoA being highest among all regions at 4.7% and only 2.1% of the portfolio being at risk (overdue).
– by Sai Deo
Sai is a PGP-1 student at IIM, Ahmedabad. She graduated from BITS Pilani (Goa Campus) in 2012 with a B.Tech in Chemical Engineering. Sai’s interests include business in emerging markets, sustainable growth, new business development. She also follows the venture capital and financial services space