Sunday, May 2, 2010

Microfinance ... the SKS initial public offering in India

Dear Colleagues

Thank you ... the Compartamos IPO was a wake up call ... this SKS IPO is another one. I would argue that we should really not be surprised because this is the capital market design that has been "taught" for decades and is still central to modern business and financial education.

It is my understanding that the main "raison d'etre" for the capital markets is that they provide a mechanism for the efficient allocation of capital. This is a fine academic argument ... and in some ways it is supported by the performance of capital markets ... but the decision making about allocation of capital in the global capital market system today is a disaster because it is all about profit and little about anything else.

A successful society is not the one that delivers the most profit ... it is the one that delivers the most quality of life, whatever that is! And that is the key ... what is the maximum of quality of life?

I would argue that the maximum of quality of life is not delivered in society when a few oligarchs make huge profits and everyone else is struggling. A wealthy elite may be happy with the status quo ... but is this good enough when perhaps as many as 4 billion of the people on the planet are poor and hungry?

At the moment the capital market is driven simply by the idea that progress is more and more profit, and allocates capital accordingly. This is a system that applauds the "bubble making" that creates profit ... no matter what are the underlying economic fundamentals.

In my view there is a relatively simple solution to the dangerous dysfunctionality of the capital market system as we have it today ... there has to be another dimension to the metrics of progress and performance ... there has to be value accounting as well as profit accounting, and all economic activity must be associated with its value impact as well as its money profit impact.

Early in my career when the corporate world was being "computerized" I worked on the development of corporate accounting and management information systems (MIS). When the MIS worked right, corporate performance was transformed ... but I recall there were many cases when the computerization went wrong, the MIS went wrong, and the business failed.

In the modern capital market the missing value dimension pretty much guarantees that the allocation of resources is going to be wrong most of the time. There is value in education, value in health, value in infrastructure, value in quality of life ... even though making quarterly profits in these segments of the economy is unusual, arguably undesirable and maybe impossible! In the USA there has been "profit progress" for decades ... but in the same decades the quality of life of maybe 70% of Americans has deteriorated, their family equity has been gutted, the infrastructure (road, bridges and tunnels, rail, water, sewage, air traffic control, schools, etc.) has been allowed to waste away. Profit has been increased ... jobs have been relocated. Allocation of capital has been just about profit and to h*** with everything else!

Microfinance has the capacity to deliver a social value ... it can also be structured to deliver profit. There can be both ... but in general the capital markets are looking to fund organizations that are going to deliver profit ... and it is fair to say that where profit is the primary goal, there is a reduced delivery of social value to the detriment of society as a whole.

Right now, capital markets really don't care about the social value dimension ... and they won't ever care until society measures both profit performance and value performance. Change the way the game is scored and you will change the way the games is scored.

Peter Burgess
This message was posted to a thread about the SKS initial public offering (IPO) ins India. It was in response to an article that appeared in Forbes magazine written by Michael Schein of ACCION and Michael Chu, now at the Harvard Business School and I understand previously associated with the Compartamos IPO in Maxico.
Microfinance Goes Public
Michael Schlein and Michael Chu

India's largest microfinance institution, SKS, recently filed a draft prospectus to sell shares on the India stock exchange in an initial public offering. This IPO will be an historic milestone for the poor in India and beyond, opening the door to assisting them on a scale never seen before in this region.

Microfinance's journey from nonprofit into the heart of capitalism is a hot topic these days, and this IPO will be no exception. Specialized media, the business sector, the development community, philanthropy and the microfinance industry--all will debate the ramifications of this event.

In the midst of so many perspectives, it is important to focus clearly on what is really at stake here, not only in India, but around the world--the role microfinance and the capital markets can play in fighting a truly universal problem: poverty.

Over the last few decades microfinance has grown in scale by orders of magnitude--from reaching tens of thousands to now reaching 150 million of the world's poor. This spectacular growth was unleashed when nonprofits began to evolve into regulated sustainable microfinance banks fueled by access to the capital markets. This evolution has been a natural outgrowth--not a contradiction--of the mission of microfinance.

Reaching 150 million of the world's poor is a remarkable accomplishment. But there are about 1 billion poor people--a significant percentage of whom live in India--who may benefit from microfinance, and so there is much more work to be done to build a truly financially inclusive world.

The core question we need to ask is how can microfinance benefit the greatest number of people at the lowest sustainable prices in the quickest possible time? This is certainly what is most relevant to the poor themselves.

And this is where the IPO of SKS comes in. The IPO's value for microfinance goes well beyond SKS itself. To achieve real impact, you need not one institution, but a group of institutions, whose fierce competition will expand coverage faster than any single entity ever could, delivering the widest array of products at the lowest price. In other words, to succeed we need to create a wholly new industry, dedicated solely to meeting the financial needs of the poor. We know this is true because we have seen it take root in Latin America.

Bolivia has been a pioneer in building microfinance services. Today it is a model for the world, with the lowest microfinance interest rates in the region, because top-tier financial institutions battle each other to serve low-income families.

In Peru, rates are coming down and product offerings multiplying. Why? Because 44 of the 55 regulated banks and lending institutions in the country have joined the competition in microfinance. The same thing is beginning to happen in Mexico. In the three years since the IPO of Compartamos, Mexico's largest microfinance institution, the number of organizations focused on lending to the poor has quadrupled from 200 to roughly 800.

It is a momentous and exciting time for microfinance, a global turning point. But there are obvious and important caveats we must take into account as a global microfinance industry is created.

First, we must make clear that financial inclusion is not a silver bullet. It is one tool--and we believe a very powerful one--among many in the global fight to defeat poverty.

But to make lasting progress, many high-impact interventions must act in unison, including health care, education, housing, basic services like nutrition, clean water and sustainable energy. That will take a coordinated global commitment across the sectors, of which the financial sector is only one.

Next, as we build this industry, we must also build trust. Led by the Center for Financial Inclusion, microfinance organizations around the world have come together to ensure that microfinance protects its client, the poor. This means redoubling the commitment to transparency in terms of pricing, and the terms and conditions of all financial products.

It also means requiring lenders to ensure that clients do not borrow more money than they can repay or use products that they do not need. In India, specifically, we have seen instances of overlending juxtaposed against vast areas that remain underserved.

Finally, while we must be thoughtful, we must also be ambitious. Successful new industries are created when a new activity is capable of generating superior--not average--returns. This is what motivates entrepreneurs to venture into new fields, allows them to reinvest and continue to grow rapidly, and encourages capital markets to assume the risks of an emerging opportunity.

For centuries, access to financial services has changed the lives of the middle class and wealthy of the world. That the power of finance can be unleashed now to transform the lives of the poor is the true significance of the IPOs of the world's most prominent microfinance institutions.

Michael Schlein is president and CEO of ACCION International, the nonprofit global microfinance pioneer. Michael Chu, currently on the faculty of the Harvard Business School, is a former CEO of ACCION who participated in the founding of Compartamos Banco.
Subsequently there was a response by Milford Bateman, and expert on the Microfinance sector and author of the upcoming book "Why Doesn't Microfinance Work? The Destructive Rise of Local Neoliberalism".
Posted by milfordbateman | 05/01/10 10:10 AM EDT
Mr Schlein and Mr Chu are deeply mistaken not just in their support for the SKS IPO, but in the belief in the 'power' of microfinance too. How many times does it have to be pointed out that outreach is simply not an impact? Most communities in Bangladesh, Bolivia, Mexico, Bosnia and many parts of India (especially Andhra Pradesh) are now vastly over-supplied with microcredit, and the result is very bad indeed. In these countries the typical local economy has been denuded of its growth and development potential. The most growth-oriented small businesses can access no capital, largely because it is channelled instead into for-profit microfinance institutions and so into tiny and unsustainable microenterprises. For the most emblematic form of proof just consider the village in Bangladesh - Jobra - where Dr Muhammad Yunus effectively started the whole microfinance movement back in the late 1970s: unfortunately, Jobra remains trapped in endemic poverty and suffering, and virtually the only structural change since the 1970s is, rather ominously, widespread indebtedness.

Specific mention in the article is made of Bolivia. But are Mr Schlein and Mr Chu aware that the massive penetration of microfinance in Bolivia since the 1990s has signally undermined the situation in this very poor country? Most potentially sustainable small businesses simply went without capital, while the tiniest petty trade-based units and postage stamp farms worked by poor Bolivians were bowled over with expensive microcredits that they could do little productive with. One result is that the failure rate of microenterprises in Bolivia is very high, which translates into the poor being plunged into even deeper poverty. And as many academic studies confirm, high levels of repayment are nevertheless secured in spite of this high failure rates, but only because equally hard-pressed family and friends are approached to help out with financial support. In total, Bolivia has been undermined by the ubiquity of microfinance, not helped to develop and reduce poverty. Thankfully for Bolivians (though not for those making huge
profits from the provision of microfinance) the government of Evo Morales has taken strong steps to reduce the population's damaging dependence upon high cost microfinance, and they have introduced desperately needed affordable finance programs aimed at potentially sustainable and growth-oriented small businesses and family farms and cooperatives.

Finally, as to the implications of the SKS IPO itself, Mr Schlein and Mr Chu appear not to fully comprehend the enormous damage being done. They make no mention of the fact that Mr Vikram Akula has personally pocketed $12 million from the sale of only 25% of his share options in advance of the IPO, with other senior managers making almost as much. As the USA has seen, the impact on social capital and community cohesion of such naked Wall Street-style profiteering is hugely negative. Moreover, when in a few years time Mr Akula and his colleagues sell their remaining 75% of SKS and catapult themselves into the very top rank of India's multi-millionaires, the destruction to local solidarity and moral codes is likely to be greatly amplified. Nor do Mr Schlein and Mr Chu make any comment on the fact that the initial capital inputs into SKS were largely provided by the community, but they have been rather presumptuously taken into the private ownership of Mr Akula and colleagues (that is, capitalised into the share price). Do they really have a moral right to appropriate such resources provided by the community and
aimed at benefitting the poor above all others? Finally, there no mention of the fact that India is already vastly over-supplied with microcredit and a 'bubble' has clearly formed. And it is not as if the results of such a massive supply of microcredit are anything like uplifting: massive over-indebtedness and related individual and family stress are the norm, financial support has been channelled into completely the wrong types of industrial units and agricultural units, and rural suicides have risen dramatically because of growing and unpayable debt to rapacious microfinance institutions. If the 'microfinance bubble' bursts very soon, as some are
predicting, we may even see a major reversal of what few gains have been made at the local level. It seems that it is not just Wall Street that 'doesn't get it', but many supporters of microfinance too.

Milford Bateman
Another observer commented correctly that IPOs serve not only to raise capital for an important economic activity, but also are a favored "exit strategy" for people that have done something and want to monetize it ... that is to turn their efforts into being members of the multi-millionaire elite.
Posted by soman1981 | 05/02/10 12:09 AM EDT
I agree with Mr. Milford Bateman. I would also like to add that I feel this IPO should not be glorified for other reasons as well. SKS is not raising money from the public offering so that it can lend to more people at lower rates. Rather existing shareholders are offloading their shares. Moreover, the key management has already cashed out ahead of the IPO which was news in the papers in India showing a complete lack of commitment to the organization. This IPO is only an example of how private equity players and founders can exit and make money and has nothing to do with raising money for the poor.
The financial debacle should be an opportunity to change the way the game is played, but I am not optimistic. There is a lot of talk about financial sector reform, but none of the initiatives include as far as I know any serious reform in the way the game is scored. As a former professional accountant, I am aware how much the accounting and financial reporting rules have been compromised over the years ... all in favor of making the money profit reporting more "favorable".

There is some hope ... perhaps. Community Analytics (CA) has the value dimension ... and does not look at performance from "inside" the organization but from the perspective of the community. The only impact the community sees is what the organization delivers ... good or bad. If the organization delivers value to society, that is good ... it is delivers nothing, that is another thing, and if the impact is bad then this is now on a record.

The CA value dimension includes value chain analysis ... because profit tends to be created by a chain of economic activities ... and all along this chain there is a value change dimension. Multinational corporate profits attract global capital market funds, but they are associated with huge value destruction and value adding along the value chains they use to build these profits. Get these value impacts onto the record, and corporate economic performance can be looked at in a more rigorous and meaningful way.

In the meantime, the SKS IPO will concentrate wealth ... and likely become a case study for how to profit from microfinance sector investment.

Peter Burgess

1 comment:

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