Good Business Can Be Good Development

My fellow bloggers have raised some interesting points on the SKS IPO, and I hope that my experience as CEO of MicroVest can help add texture to some of these themes.

I want to make it clear that MicroVest and I share the belief that commercial microfinance leads to better governed and run institutions. In turn these organizations offer improved, more diverse products and services with greater geographic outreach at lower costs. To sustain growth and meet borrower demand, the industry needs to attract capital and the most sustainable way is through commercial markets.

I believe that an IPO seems like a natural extension of this process and an appropriate growth mechanism for SKS at this time. We have seen in market after market that the commercial approach has attracted additional entrants with competitive new business models that have driven down the cost to end borrowers. Markets have been quite effective in disciplining MFIs that failed to adapt to competition or strayed into predatory lending.

All that said, from a commercial standpoint I am concerned that the rush to IPO could encourage some MFIs to relax attention on quality underwriting, leading to over-indebtedness in the short-term.

The microfinance market was started with donor funding, most likely a prerequisite for the stunning growth we have seen in the commercial scaling phase. Regrettably, while donors can be very good at targeting donations they are rarely good at intermediation or commercial governance. I hope that the improved governance and transparency that accompanies an IPO will assuage my concerns about unfettered credit growth.

Early subsidies/grants are common at MFIs and should be congratulated for their success                                                                                         
All new businesses need seed funding to grow to a profitable level. All new industries require a market infrastructure to reach scale. Increasing financial services for the working poor is a key focus of governments, multi-laterals and NGOs, and grant money is available for this effort. I expect that every future IPO’d MFI will have received grant money in its early stages of growth and will have benefited from donor funded market infrastructure support.

The donors that made these grants and subsidized investments should be congratulated for doing an excellent job in supporting the growth of the industry and of some successful MFIs. They have been successful in scaling economic activities well beyond the scope of early grant objectives. It seems counter-intuitive to attack an MFI for accepting funding that facilitated reaching the mutually shared objective of both the MFI and the funding parties – providing access to finance for increased numbers of the working poor.

What appears to have caused consternation is the transfer of value from NGOs to managers and investors. I agree fully with this concern. However, I believe that the cause of this questionable appropriation of value is not the commercial nature of scaling MFIs. It is rather the result of poor governance and oversight on the part of some donors, many of who left NGOs with governance structures designed for managing income statements of thousands of dollars. These transformed NGOs now have balance sheets worth not just millions but billions of dollars. There are numerous cases of abdication of governance on the part of donors as they have prematurely moved to the next focus country. If no one bothers to guard the hen house, I fear we may be sanctimonious to condemn the fox after the fact.

Governance will continue to improve as a publicly listed company                                                                                                                            
An MFI that transforms from a non-profit institution to a non-banking financial institution undertakes a huge step in the level of governance that is demanded by the commercial sector. In my experience this brings a significant improvement in the level of transparency, professionalization and market standardization. The increase in governance and reporting required as part of the IPO process can only lead to further improvements and benefit the clients of an MFI. 

In my opinion, the lack of governance and oversight by early donors has been responsible for many of the questionable transfers of value that have taken place in MFIs around the world. Grant making institutions have shown a weakness in delivering a high level of serious commercial governance. NGOs without true independent boards representing the public, that vote for excessive salaries and sweetheart share purchases, are responsible for the failure of effective governance oversight, not IPOs or commercial microfinance.

In short, they are the result of donors working in areas that are not their core competency.

Expansion into new services does not equal mission drift – as long as consumers are protected                                                                                   
The SKS IPO has raised money for investment into operations. Some of this money may be spent on developing new products and services for the working poor that may not be deemed traditional microfinance methodologies. Some would have us believe that any form of pro-poor banking that is not village banking represents mission drift. 

I strongly believe that this should not be treated as mission drift, provided that the services are in-line with the Client Protection Principles championed by the Center for Financial Inclusion. In fact, I believe that it should be celebrated because new innovations servicing the poor do not need grant money to get off the ground.

I would not be surprised to see NBFIs like SKS using IPO funds to expand their savings products, home improvement and education loans. I believe that the demand of the working poor for financial services, (their revealed preference), will ultimately dictate the direction of well run commercial MFIs. I feel that this will be a superior outcome for the working poor, and far more important that an academic discussion to define mission drift.

Any capping of interest rates will hurt the poor                                                                                                                                                       
An interesting argument has crept into the IPO debate. Should MFI returns be limited where there is no barrier to entry, or no oligopoly exists? There are some development thinkers that believe the market mechanism does not result in the best outcome for the greatest number of people in the medium term. I disagree. 

There are other thinkers who would have us believe that credit is a different economic input from say sugar or cola syrup. They argue profit should not be made from interest. This is a value judgment. I might feel that selling very expensive and nutritionally questionable fizzy water to the poor is bad development or even offensive to my values.I, however, would not argue that we should limit the profits of all businesses that supply consumer demand that I find offend my values.

I would argue that we should have enough faith in consumers to make their own decisions.

It has been suggested that limiting the profits of MFIs is a way to prevent exploitative profiting off the poor. The only realistic way that we can see to limiting profits is to cap interest rates. This has been counterproductive, most recently in Nicaragua and Venezuela. I believe that any implementation of interest rate caps will perversely and significantly hurt the working poor. MFIs will be forced to focus on a very specific, targeted market that is cheap to serve and reliable in repayments. Incentives for innovation will be destroyed, as will the desire to offer small loans to the poorest of the poor or to expand to rural areas that are more expensive to service. At the end of the day I fear that we would see MFIs begin to mirror the worst attributes of large utilities: minimal competition, low levels of efficiency and a lack of product innovation.

I acknowledge that there will be individual cases where MFIs can sustainably reduce interest rates to the benefit of the working poor. I also know that we have never seen markets with low barriers to competition where efficiency hasn’t increased and pricing hasn’t decreased with competition.

MicroVest will continue to utilize our strong predatory lending and over-indebtedness screens in our due diligence procedures. We will continue to search for those institutions that serve the working poor well and treat them as partners. We believe that these are the institutions that will grow and be successful.

We think this is good business and good development.

My major concern is potential for misalignment of short-term investor needs vs. long-term strategy                                                                            
I accept that there is potential for misaligned/unknowing owners of publicly traded MFIs to push management toward predatory lending practices in search of increased profitability in the short-term, forgetting that productive lending is the basis of successful microfinance. The leading Indian MFIs, through Sa-Dhan and MFIN, have made great strides toward instituting industry best practices. 

Buyers should be wary of an MFI rush to market for quick IPOs. There is a grave risk that in pursuit of a successful and timely IPO listing, MFIs could lead to poor decisions over growth, underwriting and governance. My underlying belief is that the MFI managers in India, and elsewhere, understand that the only way to have a growing sustainable microfinance business is to service the needs of their clients effectively and fairly. We have witnessed market discipline punish financial institutions that had forgotten the core of good pro-poor underwriting. I hope that it will not take the failure of an MFI to make this clear to public investors.