Saturday, April 17, 2010

Microfinance as a business

Microfinance as an industry has started to grow up. However it is not all rosy. An impending IPO of SKS has added more fuel to the naysayers calling MFIs yet another loan sharks, sum-prime like bubble, profiteers and what not.

A lot of these are coming from western media like WSJ who have started covering MFI sector almost every week and obviously a lot of it is negative. They generally pick up on small village and show how MFIs have flushed them with loans or how they have all defaulted as a community. A lot of it, I think, is plain BS! These Americans have no freaking idea of whats happening on the ground. I think what western media clearly fails to comprehend is the sheer size of the market and diversity of this country...or they don't want to. Paint a bleak picture and their readers would get some kind of sadistic pleasure out reported failing of yet-another-poverty-elimination-experiment.

Viability of Microfinance: A thought experiment
Microfinance institutions(MFIs) lend to poor people who actually do some 'real' work and repay it back to MFIs overtime. For this MFIs charge a good amount of interest rate. Now lets take an example of a farmer taking a loan for cow. A good cow(not a jersey) which costs about INR 10,000 gives about 10 lts of milk. This in rupees terms comes to about INR 80 per day. Even if we take 20% of this as costs of medicines etc and assume that a cow gives milk only half the year then he earns about INR 30 or per week INR210. Now a typical MFI loan of Rs.10000 with 50 installments has an EMI of about Rs. 230. I don't understand who it is difficult for a farmer to service this loan when cows are just a side business for a farmer. Moreover he'd get good returns on his 10K loans after he has paid of the loan in one year.

Why scaling up is a necessity for MFIs
Scaling up is not a luxury but a necessity. Those who do not scale their operations cannot ever make significant dent in the bleak universe of poverty. A typical MFI starts with about 100 clients and quickly grows to about 1000 clients. The typical loan size is about 10000 which means the amount of money disbursed is about 1 crore INR. That is a large village or a small town to whom they can reach. After this they start to stagnate in need of better management, IT, manpower etc.

India has 110 crore people. 30-70% of which are in dire need of funds to scale up whatever they do and become "non-poor". The market size is about 100 million clients. If an MFI just reaches 1000 people then it is not doing enough. In my view when they reach about a million clients then all they have captured is 1% of the market which still is clearly not enough. Even if we have 100 such players still there would be room for more MFIs to service cycle 2 and 3 loans of these people. In India MFIs of size serving more than a million customers was 3 according to this report in October 2009(page 11). Therefore saying MF sector is a bubble is a joke! There is a clearly a lot of room to grow.

There are many more challenges for smaller MFIs. Fraud by their employees due to weak monitoring, difficulty is securing credit lines, higher cost of loans etc. Larger MFIs with good governance can tide over these difficulties with ease.

It is About time we started looking at MFIs as proper for profit businesses. We have reached a point where MF sector needs to kick off the training wheels and switch to corporate model and government should respond with creating solid guildlines and rules for this sector. RBI has very clearly shown that with the banks and now is the time that they do it for MFIs/NBFCs. They also need good governance and that needs talent. Without money this sector cannot bring in talented people. This sector needs good IT, solid reporting tools, CIBIL like credit bureau, professional consulting firms etc. All of this can only come along if these MFIs start scaling up, bringing to the table economics of scale to pay off corporate salaries and put in good solid systems.

Profits not extraordinary profits
What Md. Yunus started was a NGO like Bank for poor but clearly the self governing, non profit model is not for everybody and that model cannot scale for everybody. Not everybody is Md. Yunus. He has very clearly shown us a path. Not everybody is a as talented or motivated. Moreover greed is the primary reason why farmers have suffered for so many years. Allowing it all over again would be foolish. This is a capitalist economy and everybody needs to earn his/her bread. If poor are benefiting from the loans MFIs provide them and earn profit on it then why should MFIs not be allowed to earn some profit. Having said that extra-ordinary profits is something what good RBI regulation should prevent from happening.

Note: This post is about what I think & feel and not of my employer.

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