What’s wrong with Micro-finance Institutions? Practically everything as the case of SKS illustrates
When we started out in development a couple of decades ago, we instinctively targeted to reduce the influence of moneylenders, if not eliminate them completely. Why? They were seen as the traditional oppressors and exploiters in society. Their powers often overlapped with those of their caste and traditional village leadership.
Micro-savings and revolving loans often worked very well. Self-Help Groups (SHGs) being small and homogeneous, are controlled by members where borrowers themselves play a key role in the development of SHGs. They contribute small savings, regularly attend the meetings and participate in making the rules related to loans, interest rates, repayment schedules and mechanisms. These groups are thus are more likely to be characterised by self-management and self-reliance.
This is until the much-hyped micro-finance institutions (MFIs) burst into the scene. They started easing out NGOs on the specious argument that we were not equipped with our limited capability to run micro-finance lending programmes. These MFIs operate under these two beliefs:
“Having access to expensive credit is better than no credit” and “the observed rate is where demand equals supply”.
These two beliefs were ironically the very same fulcrum the traditional moneylenders operate around.
The result is an “animal farm” situation where we are now not able to distinguish between “pigs” and “humans” and vice versa. In fact, moneylenders have got a makeover by re-branding themselves as MFIs. A good example is Mohammed Yunus of Grameen Bank who comes from a traditional money-lending caste. And of course, he got the Nobel Prize and so did Al Gore & Pachauri. And thank God, the Nobel Committee did not confer Gandhiji the same distinction, by clubbing him with these scamsters. In India, it is perhaps not a coincidence that Vijay Mahajan, described as the Father of Microfinance, also comes from a traditional money lending community.A creature of neo-liberalism, the idea of giving small loans to poor people became the darling of the development world, hailed as the long elusive formula to propel even the most destitute into better lives. And boy the neo-liberals loved it as this rhetoric strongly resonated with their love of the non-state, self-help, fiscally-responsible and individual entrepreneurship beliefs. MFI besides fits very well with the main tenets of neo-liberalism that includes macroeconomic policies focused on eliminating inflation rather than expanding job opportunities; cutting government subsidies - including credit subsidies and opening domestic markets to imports, multinational investors and speculative financiers. The neo-liberal environment encouraged the image of MFIs to be spun as a golden bullet to alleviate poverty, inflating its sense of success and underplaying their lack of holistic vision and action.
Still there were many within the NGO sector, willing to speak out. Michelle C. Schaefer in her feminist blog highlighted the following:“MFIs overlook several of its realities, including the shame and fear that many poor people associate with debt (suicide rates are high amongst those who cannot repay), illiteracy (not being able to read contracts), the possibility that debt is the last thing poor people need, macroeconomic emergencies and natural disasters — let alone personal illness, deaths within families, dangerous work conditions and spouse brutality.Micro-finance detractors also list corruption, inflated interest rates, lack of savings services, non-transparent transactions, not reaching the “poorest of the poor” and joint liability amongst its many faults. One Bangladeshi man even describes Yunus as the world’s biggest loan shark.”In the Indian context, perhaps the best refutation of MFI as poverty alleviation’s golden bullet comes from seasoned MFI consultant, Ramesh Arunachalam:
”Even if you lend at 0%, returns from agriculture would most likely be negative and micro-finance skirts agriculture and most of India’s poor are engaged in agriculture. So, micro-finance cannot and should not be expected to make a serious impact on poverty in India”Prakash Bakshi, Executive Director, NABARD in an interview to the Economic Times was even more categorical:“In a static village economy, there is little scope to have too many petty traders. Two-thirds of the villagers directly live on non-cash-crop agriculture, and another 20% are small-time artisans. The cycle of economic activities for these people range from about six months to one year. None of them generate income to meet weekly repayments, and none of these activities generate a rate of return to afford interest rates of 20-40%.
And if they borrow — and many are compelled to borrow at such interest rates because banks have failed to provide them with credit that they deserve at affordable interest rates — they would never be able to rise from their levels of poverty, and very often just go back a few years in their economic status.”Findings from several studies converge that poor households do not benefit from micro-finance; it is only non-poor borrowers who benefit. A vast majority of those with starting incomes below the poverty line actually ended up with less incremental income after getting micro-loans, as compared to a control group, which did not get such loans.
The real weakness of MFI is the key assumption of the business model that treats each and every borrower as an entrepreneur. Most poor people do not even have the basic education or experience to understand and manage even low level business activities. They are mostly risk-averse, often fearful of losing whatever little they have, and are struggling to survive.
Well Oiled Racket that makes Poor, Poorer, and the promoters and financiers Multi-Billionaire Tycoons
According to the Washington Post: "Private capital first began entering the micro-finance arena about a decade ago, but it was not until Compartamos, a Mexican firm that began life as a small non-descript NGO whose public stock disinvestment generated $458 million in 2007, that investors fully recognized the potential for a windfall.CARE, started a micro-finance institution in Peru in 1997. The initial investment was around $3.5 million, including $450,000 of taxpayer money. But a year ago, Banco de Credito, one of Peru’s largest banks, bought the business for $96 million, of which CARE pocketed $74 million."From then on, there was no turning back. Micro-finance ended up a money making machine for almost everyone. Mark Straub in his blog on the rise of the MFI phenomenon in India:“Collectively, the Indian micro-finance sector raised over $500M in private equity last year alone. With on-paper valuations of these companies in the hundreds of millions (dollars not Rupees!), and in at least one case over $1 billion, sales of founders’ stock in private secondary sales has created Hyderbadi millionaires seemingly overnight, something unseen in India outside of BPOs, Bollywood and corrupt politicians.The rise of micro-finance as a venture capital-backed asset class, now poised to see multi-hundred million-dollar initial public equity offerings in the next 12-18 months on the Indian stock exchange. Well known giants of Indian micro-finance who serve millions of clients – SKS, Spandana, SHARE and Bandhan – as well as upstarts Ujjivan and Equitas, have attracted millions in risk capital from top global venture capital firms and sovereign wealth funds, in several cases transforming themselves from non-profit NGOs to corporations in order to raise capital and attract top management talent.”Ramesh Arunachalam in a perceptive analysis in Malcolm Harper’s blog, warns against the dangers of this trend of rapid commercialization by drawing an apt parallel with the Satyam:“MFIs have to manage multiple stakeholders including investors and balance their expectations well. This is also very critical for MFIs especially because of the traditional orientation of the sector and its predominant focus on the low-income customer segment.The Satyam fiasco happened because the promoter was hugely focused on investors (shareholders) and wanted to create value and wealth for them in an aggressive manner – and he did everything possible (legal and illegal) to bolster performance, quarter on quarter and year on year for almost 7 years. In fact, this aggressiveness, haste and urgency are perhaps what led Satyam to grow unnaturally and eventually fail. As one of the employees of Satyam aptly argues, Mr Raju would always want to take giant steps and go from 100 to 1000 rather than 200."The IPO of SKS, one of the largest MFIs in India, saw it over-subscribed by 15 times; their Ten-Rupee share was priced at a premium of Rs 985 - showing how much the market had confidence on their profitability while “banking with the poor”. With earnings per share (EPS) of Rs 32.98 as on 31 March 2010, it trades with a price-earning (P/E) ratio of over 50, given its expanded equity.
Sucheta Dalal explained in her blog how over-priced the SKS script was:“At the upper price band of Rs 985, the company is demanding a valuation of almost 50 times its FY10 earnings. For a non-banking financial company (NBFC), which has a limited period of operational history and no dividend record, the valuation looks very much stressed.
Although the company in its draft red herring prospectus (DRHP) claims that it has no competitive peers, SE Investments Ltd, a micro-finance lender, is already listed on the Bombay Stock Exchange (BSE). SE Investments' EPS stands at Rs1.21 in the first quarter of FY10. The company posted a net profit of Rs17 crore (10 Million is a crore). Based on the EPS of the first quarter of FY10, its P/E works out to 11 (annualized), which is lower than the PE of SKS. SKS reported a net profit of Rs 174.8 crore on total revenues of Rs 958.9 crore and an operating revenue of Rs 873.50 crore for the year ended 31 March 2010. It had a negative cash flow of Rs 541.20 crore for the year ended March 2010."SKS Share is a Trading Bear’s DreamThe most interesting question is whether SKS can grow 50 times its FY10 revenues during F11 season. The Economic Times gave some vital clues to the answer:“More than 60 employees of the embattled micro lender, SKS Micro-finance, have each made more than Rs 1 million selling their shares after listing, making a return 29 times their investment in three years. Employees working in various capacities - ranging from an assistant manager to a vice-president - have sold their holdings in at least 130 separate transactions ever since the Hyderabad-based firm listed its shares, data show.So far, the employees have sold 1.96 lakh (100,000) shares, accounting for nearly a sixth (or 16%) of what they got through an Employee Stock Purchase Scheme (ESPS) in 2007. Though a comparable macro data on share sale by staff are not available, the number of shares sold immediately after the listing is seen as a high number. They got the shares at an average price of Rs 38 per share and in less than three years time; the same shares were sold at an average price in excess of Rs 1,100 - a cool profit in excess of Rs 1,050.SKS has introduced a mix of employee stock options and stock purchase plans since 2007, including one for independent directors. Eligible employees were encouraged to buy their entitlement in the stock purchase scheme, with interest-free loans for a certain time period.Under the first stock option plan, only SKS chairman Vikram Akula was allotted 9.45 lakh shares at a price of Rs 49.77 per share in December last year. At the time of filing the offer documents, just before the public offer, Mr Akula held option rights for another 2.68 million shares, accounting for little over 4% of pre-issue share capital. Earlier in February, SKS Microfinance's founder and chairman Dr Vikram Akula sold 9.45 lakh shares at Rs 6 39 per share to Tree Line Asia Master Fund (Singapore) Pte for $12.9 million"All pretense of altruism was cast aside, and the so-called poster boy of MFI demonstrated his ugly face as a profiteer prompting Sucheta Dalal to comment:"Another related fact is that out of the total issue size of 1.68 crore shares, more than half or 55.7% shares are put on sale by Sequoia Capital. According to the DRHP, the key management of SKS Micro-finance has decided to sell their stake in the run-up to the IPO under both stock option and stock purchase plans at a significant premium. Collectively, the transactions would imply a sale of 1.42 million shares or 8.4% of the IPO size. Although the Reserve Bank of India (RBI) has approved the transactions and there is nothing illegal about en-cashing investments, this raises a larger question of commitment on the eve of an IPO."The selling spree is very likely an indicator of SKS employees’ lack of trust in the company’s near term future. SKS employees, including Vikram Akula, by booking profits, were implicitly stating that they have no confidence that SKS can grow 50 times its FY10 earnings to maintain its present P/E.If you are an equity trader, this could be interpreted as a clear signal to hammer this script down in the most aggressive way. Particularly so as the Andhra government's clamp down should squeeze its growth in the most profound way, given that 40% of its lending is accounted by this state. While the High Court order put these restrictions on hold and allowed the lenders back in the field this week, close to half of all borrowers are continuing to avoid payments, micro lenders say. Local politicians have joined the issue by telling their constituency not to repay MFI loans. If this situation continues for the next few weeks, it is easy to see it can turn into a repayment crisis that can ring the death bells for many in the industry.
MFI: Return over Capital, Highest in any other SectorThe moot question is when SE Investments P/E stands at a measly 11, what justifies SKS's whooping 50? It appears to be intricately linked to the allotment pattern. The issue consists of a fresh issue of 74.45 lakh shares with 50.37 lakh shares reserved for retail investors. Qualified Institutional Buyers (QIBs) were allotted one crore (10 million) shares. The company expected to raise Rs 1,427 crore - Rs 1,654 crore through this IPO, which they over-achieved.The key to understanding all these numbers is the differential price for QIBs/high value investors and retail investors. While retail investors had to shell out Rs 985 for a SKS ten-rupee share, the latter together with SKS’s existing venture capitalists, including some private equity funds that have stakes in these companies all paid below the listing price and made a killing.
And just who were these QIBs and high profile investors? Big global names like pseudo socialist and financial racketeer, George Soros, pseudo-corporate saint, Narayanan Murthy, the founder of India's, IT giant, Infosys and pseudo-Green Vinod Khosla of Sun Microsystems. Their profiles are sketches below:George Soros. In 1992, the lead fund, Soros’s Quantum Fund became famous for “breaking” the Bank of England, forcing it to devalue the pound. Soros had bet his entire fund in a short sale on the ultimately fulfilled prediction that the British currency would drop in value, a coup that netted him a profit of $1 billion. In 1997, Soros was also blamed for forcing sharp devaluations in Southeast Asian currencies.Corporate “saint” Narayana Murthy exhorts “We need to promote commercialisation that can be legal done, ethically sound and sustainably carried forward”. If you take this character seriously then consider this. His investment in SKS quadrupled overnight on allotment of the share!! Saint Narayanan Murthy even outdid old Soros. The shares were acquired by Soros Quantum Fund was for a total sum of Rs 19.08 crore which translates into a price of Rs 636 per share. Soros therefore shelled out more than double than the “Saint” did. Narayana Murthy was also quoted by the media as saying: “A clear conscience is the softest pillow in the world.” We now have an idea what kind of pillow he sleeps on. That's of course, assuming he has a conscience.Vinod Khosla. His venture company has called cellulosic bio-fuel his “real love” and invested in more than a dozen bio fuel ventures. These bio fuels are one of primary factors responsible for global food inflation and scarcity; increased starvation deaths and nutritional deficiencies; and food riots all over the globe!Their name association however prompted the market to accord a higher P/E. While these promoters, venture capitalists and QIBs laughed all the way to the bank, the retail investors as usual faces the high risk of their investment eroding in a scam-tainted company a la Enron or Satyam. Their worst nightmare is if the script becomes too illiquid to trade.
The good news is that QIBs pre IPO allotment investments are locked in and the likes of Narayanan Murthy are trapped, at least during the next two years statutory period. Nevertheless, far from giving price stability, there are too many floating stocks in SKS that trading bears can target to make a killing in the market.
As for the fate of SKS hapless borrowers, they continue to live in abject poverty. With MFIs going public, all pretense is off. Now they flaunt their real face - more accountability to private equity investors than to the borrowers (their touted mission) I guess this isn’t new at all as this is borrower’s story all over the world. Patrick Bond in his blog explains the myth of Grameen Bank and exposure of Mohammed Yunus as a fraud:“Consider this outlandish claim, made by Yunus as he got started in the late 1970s: ‘Poverty will be eradicated in a generation. Our children will have to go to a ‘poverty museum’ to see what all the fuss was about.’Grameen’s origins are sourced to a discussion Yunus had with Sufiya Begum. Describing Begum and the first 42 borrowers in Jobra village in Bangladesh, Yunus waxed eloquent.But what is the current situation in Jobra? Says Bateman, ‘It’s still trapped in deep poverty, and now debt. And what is the response from Grameen Bank? All research in the village is now banned!’ As for Begum, says Bateman, ‘she actually died in abject poverty in 1998 after all her many tiny income-generating projects came to nothing.’The legendary Malcolm Harper, once the chairperson of Indian MFI - Basix, once said, "Keeping people in debt is profitable to MFI no matter the social or economic status of customer" The case of Bangladesh with the longest and highest outreach in the world certainly validates Harper’s viewpoint.Interest rates: The Poisonous Fangs of MFIsMFIs were touted to provide the poor access to affordable credit, reduce poor people’s need to use moneylenders and indebtedness. In short, provide a much kinder, cheaper alternative to the village loan shark.Instead, they evolved as the new class of institutionalized loan sharks which neo-liberals gave respectability to. MFIs did of course improve access to micro loans but failed in their touted mission to provide affordable and gentler credit and above all, one that lifted people from the clutches of poverty. Objects of institutional financial sustainability exhort them to charge interest rates and fees high enough to cover the costs of their lending and other services.In Asia, these MFIs are estimated to charge an annual interest rate varying between 36-70 per cent. If this is considered predatory, then consider the plight of Latin American and African countries where interest rates hover beyond 100%. How do MFIs actually fix their interest rates? They claim it is based on the cost of capital (interest on loans); administrative cost of delivery; bad loan cover, and profits. Let’s look at each one of these:Cost of CapitalIndian MFI’s argue that they incur an average interest between 10-11%, equal to the interest public sector banks charge for lending to them. There are two problems with this argument. Firstly, this is a wrong equivalent. MFIs raise their capital from several sources, including grants and loans at much softer rates. The cost of capital should be the average interest as a weighted function of capital deployed for re-lending activities.Secondly, if we accept the argument that all or most of the re-lending activities are sourced from public sector banks, then they are implicitly admitting that their capital for re lending is all accounted from taxpayer’s money. Accordingly, the Indian public and parliament has the right to determine what rates they should be re-lend. In a market economy, MFIs have the choice to accept these recommendations, reject and explore alternative funding sources or shut down their businesses. Cribbing unfortunately is not one of these choices.BAD DEBTSMFIs claim that they are attaining 99-100% repayment. Such a rate is an envy of any public sector or private banks. So if we take their claims at face value, then bad debts or cost of non-performing assets should be considered negligible.ADMINISTRATIVE COST OF DELIVERY
MFIs argue that the costs of reaching the poorest, most inaccessible borrowers are high, making costs of servicing such lending high. Moreover, transaction costs are high as it costs more to handle 10 loans of $100 than one loan of $1,000. Fair enough. But it also means that if we take into account their touted mission objectives of offering affordable credit to the poor, their present business model fails to align itself to their mission objectives. Either they should change their business model that finds a tighter alignment with their touted mission or they should stop expecting taxpayer’s money to increase poverty and indebtedness in this country.A posting in the blog Smart Investor reveals that part of the problem of high administrative costs is traced to the exceptionally high salaries of MFI staff:“Gurumani was appointed in December 2008; it was supposed to be a five-year term with effect from April 1 last year. At a consolidated salary of Rs 1.5 crore (raised this May to Rs 2 crore for 2010-11) and a performance bonus of Rs 15 lakh per annum, with annual increments of up to a maximum of 100 per cent. The board had the liberty to sanction more. Plus a one-time bonus of Rs 1 crore, paid in April 2009, with a Rs 4-crore life insurance cover.”This prompted Devinder Sharma, well know food security analyst to comment:
“In any case, we are only talking of the salary and perks of the CEO. What about the other senior MFI functionaries? They too receive bountiful salaries, all derived from the sweat and blood of the poor”MFIs pretend all the time being highly efficient. If so, they would be the only sector to be an exception. Nevertheless, this pretense comes useful to them to pass on their inefficiencies as high lending costs to their borrowers.PROFIT MARGINSMFIs argue that they need a wide spread apart from all costs to provide for contingencies and growth. Fine but the moot question is how much should this spread be?
MFIs further argue that economies of scale and competition will drive interest rates down. This remains only a theoretical argument. "Mexican micro-finance institutions charge such high rates simply because they can get away with it”, said Emmanuelle Javoy, the managing director of Planet Rating, an independent Paris-based firm that evaluates micro lenders!!If at all, the average Indian MFI interests rates appear more benign than in Latin America or Nigeria, then it simply because other than factors internal to the MFI industry, the sector faces strong competition from governmental and NGO SHG micro-saving programmes in the absence of which, these MFIs would most probably formed a cartel. Past angry public and government reactions that resulted in a backlash against them, which included the arrests of MFI top leaders, like Uday Kumar of Share Microfinance Ltd as in 2007, keeping their profiteering impulses under check at least to some extent.
Sacha Singh in an interesting blog offering a critique of micro-finance has this to say as a summary:“An interest charge represents money taken out of clients’ pockets, and it is unreasonable if it not only covers the costs of lending but also deposits “excessive” profits into the pockets of an MFI’s private owners. Even an interest rate that only covers costs and includes no profit can still be unreasonable if the costs are excessively high because of avoidable inefficiencies.”Since we are aware, just a 0.5% hike in interest rates can crash the stock market, we know to what degree corporate feasibility is sensitive to interest rates. Just how much subsidies did Ratan Tata gets to produce a one-lakh car? Rahul Gandhi estimates this as Rs 66,000!. Notwithstanding this maybe an exaggeration, the likes of Narayana Murthy that now sit on the board of SKS should know better how much subsidies Infosys, the IT company he founded received to make it a global success that it is today - state governments gifting land for a song, power rebates, grants, soft loans, investment allowance, depreciation etc. It is a perversion to think the petty businesses of the poor are viable no matter high the interest rates.
If Blood Diamonds can be banned, why not MFIs?Not only excessive profits, high salaries or process inefficiencies prompts high MFI interest rates but it also arises from the need of self-inflicted pressures to quickly and aggressively scale-up their lending programmes that in turn, need excessive profits to adequately plough back into their business. While it may or may not be true that in the long-term interests rates may fall drastically as MFIs claim, the old adage reminds us that this means nothing as in the long-term we are all dead.But what we know for sure is that in the short and intermediate term, the poor are being exploited by these MFIs, promoters and investors are being catapulted to overnight multi-billionaires, international investors are plundering our foreign exchange from profits made from the blood money of poor who made poorer and more indebted. That is all that matters.If it was only exploitation, we may be tempted to take a more charitable view of MFI relevance in society. But combine this with oppressive face, we are left with no option but to seek their ban. A month ago, SKS in the state of Andhra Pradesh was accused of a series of farmer suicides that prompted the state government to introduce new restrictions on the micro-finance industry by seeking to cap lending rates and end coercive means of recovery. Last week alone, Andhra Pradesh police arrested three loan agents of SKS Micro-finance and Spandana Sphoorty Financial Ltd. after borrowers complain that they were illegally pressured by the agents to repay their small loans around $1,300.It was Shantanu Dutta in his blog that highlighted such acts of oppression is not new:“Many decades ago, Rabindranath Tagore wrote a short story titled Kabuliwallah, based on the life of the Afghan money lenders who used to do brisk business in undivided India. Largely illiterate, through a complicated maze of signs and symbols, the moneylenders kept meticulous track of who owed them how much, when was pay day and then were there at the right time and place to collect their dues.Their interest rates were of course usurious but they provided unsecured loans which their customers not having much collateral to give found beneficial. However defaults on payments were not tolerated and when patience ran out, the Kabuliwallah’s justice was rough and ready. It was during such instance that the Kabuliwallah in Tagore’s story stabbed a client, went to prison and the beginning of the story’s climax begins there.”For those of us in the field, suicides due to MFI harassment hold no surprise. But we need to question the deafening silence. Where are the voices of the likes of Christian Aid, Oxfam, Action Aid, World Council of Churches, CARE etc who ostensibly been pursuing the agenda of social justice? Are their hands as bloodied as MFIs or are they too embarrassed to take on their own kind? For that matter where are the voices of human rights groups - the Amnesty International (now headed by our own Salil Shetty), Human Rights Watch, Human Rights Law Network, People’s Watch etc. In particular, where is the voice of Arundhati Roy, the one book wonder who won the Booker Prize despite poor plot and atrocious prose who now decided to take up causes on drop of her hat whether Narmada Dam, Naxalism and Kashmir? Does she have an opinion on MFI suicides or doesn’t she?Sadly, it was left to the likes of Wall Street Journal (WSJ) to see shades of the predatory lending crisis in the Andhra suicides:“Unfortunately, due to the high investor inflows and saturation of this asset class, it looks more like the subprime industry than a financing vehicle for the underprivileged. Using targeted marketing and promises of “easy credit” and “quick cash,” predatory lenders can trap borrowers in a cycle of high interest payments, abusive fees and terms that can lead to home foreclosures, and ultimately devastate borrowers’ financial futures”.The Obama Administration clamped down on predatory lending in citadel of capitalism - the US. While the Andhra Pradesh deserves to be complemented in doing the same, the Central Government is dithering, fearing the consequences will affect the image of India as an investment destination. And why should they? If it didn’t affect the US, why should it affect us? Moreover, this government won on the plank of the Aam Adhmi (Common Man). If the Aam Adhmi means anything, the ruling Congress Party at the centre needs to show more resolve by introducing stronger regulation of MFIs, if not banning them outright.The sooner MFIs are seen as profit enterprises, the better. The longer they pretend they are pro-poor, the longer they discredit the NGO sector that gave birth to a Frankenstein. By 2014, they target to reach 110 million borrowers. Remarkably, despite two decades of operations, if statistics are to be believed, these MFIs currently reach just 20 million people in the country, a good proportionate of them, multiple counted. Yet, they succeed in gaining an attention, so disproportionate to this minuscule reach. Act now to prevent them from becoming an epidemic scourge in the country. Act now, when they are most vulnerable. And how do we know they are vulnerable? Because Vijay Mahajan, the father of MFIs in India tells us so:“We are facing collapse. Unless something changes on the ground, the industry as we know it is basically gone.”Mahajan, we have news for you. The day when the likes of you are gone, that will be the turning point for the fight against poverty!