Op-Ed: Should SKS Microfinance go Public?

A recent article on www.sramanamitra.com postulates that SKS Microfinance, which offers “several microfinance options to the poor in India for a variety of businesses from agriculture and livestock purchase to basket weaving and photography,” and has to date “provided over $550 million in microcredit,” will most likely follow Compartamos’ model and go public. According to CEO Vikram Akula and CFO S. Dilliraj, plans for growth in the upcoming years include the following:

By the end of 2008, SKS plans to add 770 new branches to its existing 696 branches to increase its members from the present 1.8 million to 4.2 million and the gross disbursement from Rs 1,200 crore to Rs 5,000 crore. Their aim is to reach 5 million families by 2010.

However, for MFIs like SKS Microfinance, the question of going public is taking place against a fractious backdrop, as debates brew furiously between microfinance gurus such as the founder of the Grameen Bank, Muhammad Yunus, and co-founders of Compartamos, Carlos Danel and Carlos Labarthe, who have been vilified by critics as “pawnbrokers” due to a recent public offering of their former NGO.

According to a recent article from the NY Times entitled, “Microfinance’s Success Sets Off a Debate in Mexico,” at the crux of the debate lies the extent to which MFIs should contribute interest income towards profits (rather than cycling profits back into the organization for the benefit of their borrowers), and to what extent accountability to investors, rather than the borrowers themselves, impacts the fundamental premise of microfinance – poverty alleviation:

Microfinance started in the 1970s with a focus on using this breakthrough to help end poverty,” said Sam Daley-Harris, director of the Microcredit Summit Campaign, a nonprofit endeavor that promotes microfinance for families earning less than $1 a day. “Now it is in great danger of being how well the investors and the microfinance institutions are doing and not about ending poverty.” He said the situation posed the danger of “mission drift.”

Even though both sides agree on the need for the sustainable infusion of capital (consider this in the following context – “Deutsche Bank estimates the global demand for microfinance loans at about $250 million, 10 times the amount that has been lent out”), the question comes down to this: at what cost? Critics argue that the model adopted by Compartamos comes at a grossly high cost for its borrowers, skewing the mission of MFIs in favour of the investors rather than the interests of the borrowers themselves, which, in the case of Compartamos, has resulted in disproportionately high interest rates (read more after the break):

After Compartamos became a for-profit company in 2000, costs fell as efficiencies increased, but the bank kept interest rates high. On average, customers pay an annual interest rate of almost 90 percent, which includes 15 percent in government tax. In much of the world, microfinance interest rates range from 25 to 45 percent. But in Mexico, high costs, inefficiency and limited competition keep interest rates much higher.

Profit is not a dirty word in the microfinance world. The question is how much is appropriate. CGAP estimates the average return on assets for self-sufficient organizations to be 5.5 percent. The figure for Compartamos was 19.6 percent in the fourth quarter.

In response, Compartamos and its proponents claim that “microfinance will help more poor people by tapping the boundless pool of investor capital rather than the limited pool of donor money.” Furthermore, according to www.defeatpoverty.com, proponents of the Compartamos model recognize that “microfinance can’t scale – from 100 million clients today to its potential market of 4 billion – without the capital markets, and the formality capital markets require.” In fact:

As part of their defense, they argue that Compartamos’s success has prompted a number of institutions, including traditional banks and retailers, to start offering financial products to the poor. “We don’t only see ourselves as a specialist in microfinance but also as the builder of an industry,” Mr. Danel said.

Moreover, prominent experts in the field such as Iskenderian of the Kashf Foundation, a well-established MFI in Pakistan, observe:

Microfinance NGOs – many of which have been part of microfinance since its beginning – have distinct social missions. To fulfill those missions, these organizations must have more capital; without access to the capital markets, they simply won’t be able to raise that money. Secondly, these NGOs want to offer new products – such as savings – but they need more money to develop these sophisticated products.

Finally, in response to critics’ claims that Compartamos charges exorbitant interest rates, and pockets a significant portion of the profits, the organization argues that higher-than-necessary interest rates are a function of lack of competition in the microcredit market, and as this disequilibrium balances out with the emergence of more MFIs, rates will automatically come down significantly.

In light of these concerns, however, NextBillion makes an excellent point:

All of us who are involved in commercial transformation—that is, moving microfinance operations from not-for-profit to for-profit institutional forms—need to think more clearly and realistically about the consequences of the resulting changes in governance incentives.

Another key question to take into consideration in the context of the commercialization wave are what specific parameters should be institutionalized in order to ensure that the borrowers’ interests remain paramount, and are not superceded in the interest of profits. The priority, in the end, regardless of the actors involved – NGOs, global financial institutions, for-profit organizations, or traditional donors – should be poverty alleviation. Profits provide an incentive for collaboration with the private sector, and enable MFIs to operate more efficiently, offer a wider range of financial services, and impact a more significant portion of the target population, but the primary goal of enabling both the financial and social empowerment of the poor should never be subsumed by the drive for profits.

Can the two – poverty alleviation and profit – co-exist? Certainly. But just as is the case with the infusion of capital into development projects through public private partnerships (PPPs), the human component must always be kept at the forefront of all collaborative initiatives. I agree with Yunus that profits are necessary to drive sustainable growth, but predatory rates of lending are absolutely unacceptable, especially given the philosophical foundation of microfinance.

Here at ThinkChange India, we are certain that this trend will continue, potentially with SKS Microfinance, but as emphasized in a previous article on the role of global financial institutions, the approach must be tempered according to the primary objective of microfinance: service to the poor.