Profits at the Bottom of the Pyramid

http://www.business-standard.com/article/companies/sks-microfinance-completes-rs-163-crore-securitisation-114022800366_1.html

I found this article interesting because it demonstrates the inclusion of the worlds poor into the formal global financial sector.  The author describes briefly how SKS Microfinance - a large microfinance organization that serves thousands of women in India  - secured funding for its operations in the short term by bundling and selling a bunch of the loans it has made.  This is a fairly common practice in the industry for other types of loans like mortgages which in part lead to the financial crises in 2008.  However those mortgage loans were of poor quality even though they were rated highly by rating agencies (sub-prime mortgages) making them poor investments.  It is very interesting that in the article it states that these securities created from microfinance loans were rated very highly (A+) by rating agencies.  This is in line with what you would expect given the low rates of default typical of microfinance loans - "the poor always pay back".  Apparently SKS has performed this maneuver 8 times before on smaller scales which might indicate the beginning of a trend where microfinance is slowly being incorporated into the financial sector.  Also significant is that the fact that SKS is a for-profit institution and it sold the loans to another private sector bank with furthers impression of the inclusion of microfinance into the for-profit financial sector.

While all this might seem promising there are still concerns with the basic premise that MFIs should be for-profit in order to be most effective.  Even though the loans have been rated as very secure by ratings agencies this is at interest rates around 30% - exorbitant by most standards.  In fact after digging a little bit more into what SKS has been doing I found they were implicated in causing suicides because of high interest rates and collection practices.  This was part of the Andhra microfinance crisis in which the government started enforcing heavy regulation of the sector because of perceived predatory lending.  Whether or not these allegations are true it casts doubt on whether inclusion of microfinance in the financial sector will lead to predatory lending and destroy its effectiveness as poverty alleviation technique.  This is very relevant for my PE because I will be working in a microfinance organization in Mumbai that may or may not be for-profit (my PE is not yet finalized).  If it is for-profit I will be able to see first hand whether this model is effective and the effect of interest levels on effectiveness.  It also means that regardless of whether it is for-profit or non-profit I will need to pay special attention of my MFIs interaction with the formal financial sector and government regulation resulting from the Andhra crisis.

50/50 Microfinance: How a 0% Interest Rate is Possible

I came across 50/50 Microfinance in my search for extreme cases of for-profit and non-profit microfinance interventions. 50/50 was an example of the latter: this non-profit MFI differentiates itself primarily by supporting its micro entrepreneurial customers with finance of which:

• Half is given as a grant, which does not have to be repaid
• Half is given as a loan, on which there is no interest

This concept seemed all too idealistic, and as a student of business and economics, many issues came to mind, the most blatantly obvious one being funding and sustainability.

Now I might be going on a tangent here, but I first wanted to talk a little about the controversy surrounding the issue of high interest rates in microfinance. We are often reminded that everything is more expensive for the poor—everything from food, transportation, housing, healthcare, and of course, money. In the context of microfinance, this has earned the industry much notoriety, and while I believe some of this is deserved (we have seen unethical MFI practices lead to further indebtedness of the poor and in some cases, even suicide epidemics because of it,) I also feel like under certain circumstances MFI interest rates are justified and are often naively criticized.

In many parts of the world—my home country, Indonesia, included—the bulk of poor people live in rural areas, which are not easily accessible, and therefore, deemed not financially feasible for most businesses seeking to enter those markets. Microfinance is generally positioned as an industry seeking to undertake financial inclusion, seeking to bring in bottom-of-the-pyramid populations into the financial sector and formal economy. That being said, there is a clear distinction between the operations of a conventional bank and that of an MFI: while conventional banks expect their customers to come to them (for the most part), it is the task of MFIs to go to their customers. This means reaching regions that have not been reached, are often inaccessible, and are lacking in terms of infrastructure, which is more costly in terms of time, money and effort! Naturally, completely from a business standpoint, these higher operating and administrative costs put pressure on interest rates. Only in addition to this is the less tangible “cost of risk” associated with lending to low-income customers.

MFIs impose higher interest rates than your average bank for a reason that is often overlooked. These numbers aren’t pulled from thin air simply because target customers are deemed subprime; these numbers cover costs of operation.

This led me to question how 50/50 can possibly function sustainably without imposing any interest rates?

This is what I figured:

The first thing I noticed with 50/50 was the scale of its operations. Currently, they are operating in four countries (Bhutan, Tanzania, Senegal, and Niger) with just over 40 customers. In comparison to most known MFIs, this is absolutely tiny!

Another thing I noticed is that their staff does not receive compensation, which is something very few known MFIs—for-profit or non-profit—actually do. Instead, 50/50 relies almost completely on volunteer work and donations.

With this combination alone, 50/50 is very different to the MFIs we often hear about—whether in the positive or negative light.

Given its small scale, it is possible for the firm to engage in more personal relationships with their customers, giving them the mentorship and attention that each of them need for their businesses to truly succeed. When you get into the big leagues of microfinance, this is extremely challenging if not impossible. Even with an MFI such as Kiva, which, since its inception has served over a million customers, it is difficult to fathom the same type of handholding that 50/50 provides to be present in their operations.

This leads naturally into the funding side of things: because they are operating at such a small scale, I feel like it is actually possible to be completely reliant on volunteer work and donations. The amount of money needed to finance each customer is absolutely tiny in comparison to most medium- to large-scale MFIs.

Like I said, this is an extreme case of non-profit microfinance. Nonetheless, from my perhaps superficial level of analysis, it does seem somewhat feasible for 50/50 to charge a 0% interest rate on its customers.

But is it effective? Is it an exemplary MFI practice as a poverty-alleviating intervention? Could it be that microfinance customers are actually more motivated and productive when an interest rate is imposed, or is there no difference? These are just some questions that I need to continue to explore, and am struggling to answer.

To find out more about 50/50, check out their website here!