Financing at the Bottom of the Pyramid

By Roopen Roy Oct 12 2010

Tags: Op-ed

In the era of “inclusive growth”, financing the poor at the bottom of the pyramid is not just politically correct but also socially desirable. Of late, it has become economically viable and remarkably profitable.

There is, however, a great deal of confusion about the term “micro-credit”. The business models that deliver micro-credit are very divergent. There is, on one end of the spectrum, the “for private profit” model. It contends that the key issue that hurts the poor is lack of access to credit not interest rates. These micro-finance institutions provide collateral-free loans to the poor and charge interests ranging from 27 per cent to 32 per cent. These rates are somewhat lower than those charged by the village loan sharks.

The case of these micro-finance organisations is that they can access loans and equity capital at reasonable rates from the market. Because they attain scale and harness modern IT systems, their transactions costs are much lower. The hefty spread of 15 per cent to 20 per cent enables them to make huge net margins. Their share prices go up. This attracts more capital and loans, resulting in expanded scale, greater capacity to lend, increased access to credit for the poor — a virtuous cycle that repeats itself as they grow bigger and bigger.

This almost sounds like a Midas story that turns to gold everything it touches. The poor borrowers (without collaterals), who are denied credit by the formal banking sector, are now served efficiently at a lower cost than their alternative supplier of cre­dit: the usurious money lender. The shareholders, including private equity investors, both Indian and foreign, receive an excellent return on their investments.

But before getting carried away, let us pause and examine the two completely different models of micro-financing. The first one — Grameen Bank is also “for profit” but operates as a “social business”. The second, SKS Microfinance, is owned by private investors. The two different models are epitomised by Grameen Bank of Bangladesh founded by Muhammad Yunus of Bangladesh and SKS Microfinance founded by Vikram Akula. Grameen Bank was founded in the late 1970s. Yunus, along with Grameen Bank, won the 2006 Nobel Peace Prize for developing the concept of micro-finance. It has over 8 million borrowers and over 2,500 branches serving 82,000 villages. It has $1.2 billion in assets and disburses loans of nearly $500 million every year. Yunus has created no wealth for himself as all profits belong to the borrowers/shareholders.

In contrast, SKS Microfinance (SKS) is a “for-profit”, non-banking financial company (NBFC). It is listed on the Indian bourses. Investors include Quantum Hedge Fund, Sequoia Capital and Unitus. Its total assets have surpassed $800 million. It reported a return on assets of nearly 5 per cent, return on equity of almost 22 per cent, gross loan portfolio of $961 million and 5.8 million active borrowers. In size of assets and number of borrowers, these two organisations look similar. In ownership design, they are as different as chalk and cheese.

A very stimulating debate took place on September 21 in New York at the Clinton Global Initiative Annual Meeting on the provocative subject “Profiting from the Poor?” Among those who debated the issue were Yunus and Akula. Yunus did not mince any words when he addressed Akula , “Let’s first define what micro-finance is. It is lending money to the poorest women for income-generating activity, without collateral, so she can help herself out of poverty. If you cross that boundary, then use another term because when you use the term micro-credit, you confuse people. Then loan sharks can say they are doing micro- credit. I say find a name for yourself: call it Bottom of the Pyramid ( BOP) credit.”

Yunus firmly believes that micro-credit is not about “ exciting people to make money off the poor. That’s what you’re doing. That’s the wrong message completely”. Because the “borrowers” in Bangladesh are also “owners” of the bank — the wealth created remains in the system. Over time, the shape of the pyramid changes. In contrast, in the SKS model, wealth is created at the bottom of the pyramid, but is shared by private investors. Akula claims that the SKS model is more scalable and delivers better customer service. NBFCs like SKS have found a profitable, underserved space between the formal credit sector and the loan sharks. But they are not a “social business”.

MNCs sell small shampoo sachets or products specifically tailored for the poor. Their sales force does not look like or pretend to be social workers.

Sam Pitroda had created a firestorm once by saying that you can drink Scotch, wear jeans and yet stay a devout follower of Gandhiji. Almost as a corollary, one could say that you can wear khadi, carry a jhola and yet remain a quintessential capitalist. Nothing wrong with that. There is a hybrid model where the BOP finance companies are partly or wholly-owned by charitable trusts for the benefit of the poor. I find these models deeply flawed. I am reminded of the famous story of a baffled Scottish farmer asking his neighbour why he was shearing a lamb at the onset of winter. “My dear friend, I am going to make a nice, woollen coat for him, so that he can survive the harsh Scottish winter.”