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Tied Up by Subsidy? The Microfinance Debate Over Donor Capital Begins

Like tumbling dominoes the microfinance tipping points keep coming as the sector continues to grow...it seems the debate over the appropriate role of international donors and grant funds in today's increasingly commercialized microfinance market has begun.

Yesterday I referenced an Economist article from March 15th, 2007, "Time to Take Credit," calling on IFIs (International Finance Institutions) whose below-market loans and grants are often thought of as "soft capital" to move on to the harder to reach sectors of development and microfinance and let private investors move in to support more established MFIs.

The article was a supplement to another Economist piece, published the same day, "Small Loans and Big Ambitions," which highlighted a study by microfinance rating agency, MicroSave, showing a trend of more and more donor dollars chasing after a concentrated top tier of the best microfinance Institutions. A summary of the MicroRate report from the Microfinance Gateway:

MicroRate Findings

                        

A private investor perspective… “IFIs should not fund the best MFIs. The argument that there is not enough private investment money to do that is absolutely wrong.” -Jean-Philippe de Schrevel, BlueOrchard

A MicroRate commissioned study of funding patterns confirmed that IFIs are not complementing private lenders, but crowding them out of the most attractive parts of the MFI market. IFIs nearly doubled (88% increase) their direct funding to top-rated MFIs in 2005. In the largest and most successful MFIs, IFIs are the dominant and growing foreign funding source. MIX data on over 160 MFIs confirm this trend. In some cases, private lenders wanted to provide funding to a MFI, but were unable to do so because they were unable to match terms offered by IFIs.

This report is being followed up by a live debate currently taking place on the Microfinance Gateway from today March 28th through Friday March 30th, (you can click here to see the posts and join the discussion).

Tomorrow I'll report on the recent close of the Unitus Equity Fund, now the largest microfinance private equity fund in the world with $23.4 million under management.

There are also rumors floating around about the pending multi-million dollar SKS capital raise, likely to be the biggest microfinance common equity placement yet in India and one of the larger deals worldwide. I would look for a story in India's Economic Times breaking news of the deal and who the investors are in the very near future.

Microfinance Donor Funds: A Hard Look in the Mirror

I was recently forwarded an Economist article, "Time to Take Credit" by a friend of mine working at a company that's starting up a microfinance division.

The article argues that institutional donors and grant givers have been able to prove the microfinance model does in fact work, and that it is now time for them to step back and let the commercial market step up to play its role in professionalizing management and contributing traditional equity risk capital and commercial debt at market rates.

I generally share this view. The fund I work for aims to generate commercial-level returns but with the caveat that it will reinvest profits back into microfinance in some form. The point of this is to create sustainable financial services companies that, while serving the poor, are also able to operate as sustainable businesses, tapping the commercial, and not charitable, markets for their growth capital in the future.

I am also of the mindset that it's time for the development funds who are trying to invest in these established microfinance houses to continue moving downstream to harder and harder to reach organizations and individuals, including microfinance organizations that are start-ups or look more like financial services R&D shops. I think international donors have done wonderful work in building microfinance into a real asset class, but I question some of the larger, multi-million dollar deals they are getting into. Instead I would suggest that they should be investing in areas and market segments which require "softer" capital and a patient, long-term investment horizon - basically, areas where commercial money still fears to tread.

In India at least, I know there are plenty of these development-focused start-ups and NGOs that need greater hand-holding support and softer capital to transform into more viable self-sustaining entities, or potentially, to perfect their product and service offerings. It seems as if everyday I meet another social entrepreneur in India with an organization which could benefit from this development capital. The org's I'm talking about range from rural education providers to irrigation product manufacturers to companies looking at renewable energies but who still need 3 or 4 years of operating money to support their "science project" experimentation. These organizations often have significant incubation periods (more than 5-7 years) before they ever sell a product or book any revenue. This is a time-frame which mainstream VC and PE investors usually won't tolerate in today's incredible demanding, 'invest today, exit tomorrow' mentality. There exists here a gap for these international donor agencies to fill, one which is much more in line with their original missions than continuing to compete with mainstream investors in the increasingly commercialized microfinance market.

Interested to hear more thoughts if there are any out there? if you decide to comment, first please read the article I linked to (it's short, only one page). Thanks!

Peer to Peer Lending

After reading Malcolm Gladwell's book a few years ago I keep seeing 'tipping points' where before I just saw coincidence.

The last few weeks have brought me in touch with more than a half dozen people asking about or doing something with peer-to-peer lending networks.

The concept of a "peer-to-peer-network" is simple. I have a similar position to you on the network (typically Internet-based) and we can both be participants or collaborators but no one up above has complete control over the network or our actions, we each participate as we choose, and generally the more people that participate, the more valuable each person's experience becomes. In peer to peer networks, the original ones music file sharing sites like Napster, there is generally significant value added through scale.

Peer to peer lending should work on similar grounds. Someone at one end is lending, and someone at the other is borrowing. Both are supposed to get some benefit from the network. But do the other rules of peer to peer networks apply here in peer to peer microfinance? If more and more people participate on the network does that change the value proposition for the individual user at either end if each loan is from one person to another single person?

A Bay Area-based organization called Kiva, which means "Agreement" in Swahili has in recent weeks captured significant attention from my friends and colleagues who are getting interested in microfinance back in the States. While I have some concerns about Kiva's model, specifically its approach to scalability and its flexibility to navigate complex regulatory regimes (like India's), the organization has clearly proven itself a pioneer in building the case that there does exist significant demand for peer to peer lending from developed countries to developing ones, or from individually capital-rich lenders to personal borrowers in need of capital. But are these models ones with long-term sustainability and the potential for-profits? (Kiva is avowedly a non-profit organization).

Several other organizations are doing different types of peer to peer lending, a few sites below...
Would love to hear comments here, especially if people have prior experience or opinions on any of these names:

Prosper - Investee of the Omidyar Network (ON), American people-to-people lending marketplace, often used by people trying to consolidate credit card debt or find cheaper capital for entrepreneurship.

Circle Lending - Another investee of ON, focused on helping people manage personal friends and family lending.

Zopa - Similar to Prosper, a British attempt to lower the cost of consumer borrowing but cutting out banks.

MicroPlace - A wholly-owned subsidiary of E-Bay, a start up looking to mobilize capital from individuals and aggregate it for use in targeted debt placements with Microfinance institutions around the world.

Which model seems the most compelling from a business point of view?
More philosophically, should peer to peer lending (particularly to microfinance clients) be done with some profit margin to make the activity more sustainable?

Just When You Thought It Was Safe to Start Lending

Unfortunately my post today reflects some updated info we've been getting from the field on one major source of lending funds that's recently dried up.

If you've been reading my microfinance posts you may have caught one from last week when I mentioned ICICI's partnership lending program, where they make on-lending funds available to MFIs and allow them to take the money and go off and create loans, which then sit on ICICI's books. The MFI in effect, acts like a service company, its core competency being customer management, not risk management.

Well unfortunately, recent feedback we've been hearing from MFIs suggests that ICICI has all but stopped this program (and the massive amounts of cash disbursal that it entails) just as the financial year is ending. Whether this has something to do with government pressure following last year's Microfinance crises in AP (more on this in a later post) or just an accounting move by the bank to rebalance its various risk portfolios prior to closing its books, the cause is not yet clear.

I do hear from some Indian private equity veterans that this type of year-end manuvear is not new for ICICI. The downside is that MFIs who are growing like wildfire and have clients coming back looking for the next loans are all of a sudden starved for cash. Not only this, but since many MFIs had come to rely on the ICICI program they had not been developing relationships with other banks. Sudden demand in the market from a handful of new players puts an onus on other banks (not ICICI) to keep lending and boosts the cost of borrowing for these shops almost overnight. I believe that fact coupled with the recent inflationary pressures in India will have a significant effect on the interest rates these MFIs get stuck with if they take on more term loans right now. Two year rates for these groups are typically about 10%. I wouldn't be surprised to see that number go up 100 basis points (1%) for loans initiated by these groups next quarter.

Hitching the Wagon to Rural Banking

I noticed a story in Mint today about how ICICI Bank (India's largest private sector bank) "expects [its ] rural exposure to boost profit in 18 months." The story also stated that ICICI plans to expand its rural exposure to 25% of its total loan portfolio within two years.

Basically, ICICI has figured out that rural lending can be profitable, and it has decided to up the ante.

This is a very positive development for rural microfinance. While microfinance lending only constitutes a sliver of ICICI's total rural loan portfolio, the two segments are closely linked.

According to Indian Finance Minister Chidambaram, in rural India, 58% of farming households and 70% of non-farming households still lack access to basic banking services. ICICI currently makes loans as small as $100 in some of these areas.

ICICI's announcement that it plans to expand its rural exposure drives home the point that the rural unbanked, who are often less educated and poorer than their urban counterparts, are not risky pariahs to be avoided, but rather, present a growth opportunity to savvy, customer-oriented businesses.

As of today, ICICI already has more credit exposure to the rural microfinance space than any other private sector bank in India. This heavy involvement has come in two ways. First ICICI has extended credit, or issued debt in the form of term loans to Microfinance Institutions (MFIs) that on-lend to the poor and/or unbanked. Second, ICICI has pioneered a service company model through which it "partners" with MFIs, allowing the bank to lend directly to village borrowers. ICICI uses these MFIs as a conduit to disburse and recollect loans to the poor. It pays the MFIs a fee for use of their credit, distribution and collection agents. The loans remain on ICICI's books, and correspondingly, help it meet certain legal "priority sector" lending obligations.

While microfinance loans have often been seen as a chartible function to be financed by donations from large corporations or government grants, the fact that ICICI's rural lending business (which operates in areas where distances between customers are greater, transaction are costs higher, and political and geological risks can be more volatile) will now add to the bottom line is another piece of evidence building the case that banking the unbanked is not simply something to chalk up to corporate and social responsibility. Rather, it can be a profitable and sustainable part of a mainstream financial services business.

Seeing the Forest for the Trees: India's '07-'08 Budget

While I had planned posts on both Wednesday and Thursday of this week, a power outage the first night, and an illness the second kept the laptop out of my hands. This stuff happens in India.
Without further delay, here's the latest news from Delhi.

The biggest story this week has been the release of the 2007 - 2008 Budget, which was unveiled by the Finance Minister, Mr. P. Chidambaram, on Wednesday in a speech to Parliament.

It seems that in trying to satisfy a lot of folks, the Finance Minister P. Chidambaram (head politico in charge of the Indian Government's money, and a chief member of Prime Minister Manmohan Singh's Cabinet) has tried to walk a fine political line, seeming to encourage further foreign direct investment and educational opportunities, but the first in a haphazard method and the later with more money rather than real cultural change in the bureaucracy.

More praise, criticism and analysis of the budget at the following links:

"Inflation was a key concern," Adrian Lim, Investment Manager from Aberdeen Asset Management

Budget Proposals may drag VC Funding by 50% in 2007, Thursday's Economic Times

"It's certainly a long road home," Managing Partner Donald Peck, head of South Asia investing for emerging markets private equity firm Actis, and Director of my firm, Lok Capital.

And an interview with Finance Minister Chidambaram here.

While it's hard to be entirely critical of the Finance Minister, as he has tended towards pro-business positions in personal and corporate income tax rates (if not on dividend taxes), there are some areas where, to me, Mr. Chidambaram seems to have missed the forest for the trees. A few examples:

- Tax benefits for Venture Capital investments will only apply to certain sectors hand-picked by the government (but why should investments in business process outsourcing be treated to better tax rules than software or real-estate? better to create a level playing field and let the investors choose where to place their bets)

- Significant increases in spending on education (a critical area for India as the education system here is widely considered to be a mess), but no new rules to tie those spending increases to better performance (or even just better attendance!) of public school teachers

- Further increases in farmer subsidies (a demand side mechanism) rather than a focus on further spending for rural roads and infrastructure (a supply-side mechanism) which would better enable the best farmers to get their produce to market faster and create agricultural competition

- Tax incentives to encourage hotel developers to build more mid-range hotels (desperately needed throughout the country) but restrictions causing those incentives to apply only to new hotels built in New Delhi and nowhere else. This is a political attempt to force developers to focus their efforts on Delhi at the expense of the rest of the country, simply to ensure that the capitol city is ready for its scheduled hosting of the 2010 Commonwealth Games

- Increases in central bank lending rates of only a half percent this winter while inflation rapidly moves from 5% a year to 7%

Finally, one gets a sense from the speeches and newspaper interviews given by the politicians here that the government is taking credit for India's current economic rock-stardom and darling status among investors. I think former CEO of PG&E in India, Gucharan Das paints a more accurate picture when he says of the economy, "[it] grows at night, when the government sleeps."

Parliament Gets Its Hands On the MF Bill

Back in Delhi after a country-wide jaunt with my parents. And while India's Parliament recently got its hands on the Microfinance Bill, I spent Sunday trying to grasp the Taj Mahal. For me it lived up to its reputation - definitely the most beautiful thing I've seen so far on my travels through India.

The microfinance bill I mentioned back in January, which has been in circulation in draft form for the last few months, was passed by the Indian Cabinet today, and looks likely to be approved by Parliament in its current format during the next session.

No significant changes from what was predicted back in January so far, except that the capital requirements for NGOs and societies have been reduced significantly causing some societies and NGOs who are already doing microfinance to complain that the small capital requirement for getting incorporated as a microfinance NGO (the proposed reduces it to ~US $2,000) will reduce the quality and credibility of the groups trying to do the activity, as untested and start-up NGOs with no background in finance hop that easy hurdle and begin to enter the MF space.

Most important though, the bill still leaves out Non-banking Finance Companies (NBFC), the kind of for-profit microfinance companies which funds like mine (Lok Capital) look to invest in. It's a bit nonsensical to exclude them, considering that as of today these NBFCs are already responsible for somewhere between a third and a half of all the microfinance business happening in India. But this comes more as a disappointment than a surprise, as the NBFCs have been excluded from the "official" channels created in this bill since its inception. This leaves NBFCs unable to take customer deposits (...think access to cheaper funds) like the trusts, NGOs and societies will be able to do.

It's also beginning to look like this bill may leave almost all parties unsatisfied as it reduces the threshold for legitimacy in the non-profit / society microfinance space while also favoring the NGO microfinance groups over the commercially oriented ones when it comes to deposit-taking.

It took 20,000 workers 22 years to build the Taj Mahal. Hopefully India's government and the industry players here will be able to build a decent financial services sector for the poor here in less time than that.

I just think there needs to be a better, fairer set of regulations to do it.

My Kind of Micro-Enterprise

A few weeks ago I spent Republic Day (India's celebration of its 1950 Constitution and the Congress's 1927 vote for full independence) back in Goa, taking a break in between trips for work.

While down there I found a place where two micro-entrepreneurs seemed to be living the dream, so to speak. On a small, secluded beach where local boats-men take in-the-know tourists, sat a pair of beer and coconut stalls. They were as flimsy as neighborhood lemonade stands, and limited in their product offerings, but perfectly placed for their target clientele: thirsty, isolated sunbathers.

One enterprising Goan, I believe Preveem was his name, offered Snickers bars in addition to his cold Kingfishers and coconuts, while his rival across the beach differentiated with pineapples. The spot made for a beautiful setting, and according to Preveem, not a bad business either. On daily supplies that I would guess cost about 1,500 rupees ($30), Preveem was able to sell his items at a 200% mark-up, turning a 50 rupee beer ($1) into a 150 rupee sale ($3).

After expenses, that could mean a profit of almost $50 a day, about 15x the daily wage of an unskilled laborer in Delhi. What was the main difference between this lucky beach bum and a city bricklayer? It's not just location. There are small roadside vendors selling the same items in Delhi and making a decent living. More accurately, I think Preveem's success had something to do with access to working capital. How many poor Goans have 1,500 rupees to spare when they wake up in the morning?

The next time I make it back there I'll remember to ask my favorite beach vendor how he got his start. I'm just hoping nobody else shows up In the meantime (I'll never reveal the location!). I don't mind spending $3 for a beer in paradise, so long as I don't have to share my beach with too many friends besides Preveem.

BW Gets $2M from FMO, and it's Super Bowl Monday in India

Waking up to watch the Super Bowl kickoff at 4:45 AM is not something most people do during their lifetime. Watching it at a U.S. Embassy Marine barracks on the American Forces Network (AFN) is something even less common.

A few friends and I had a brief chance to reminisce on life in America as we watched the game on a big screen TV in a rec room with a bar, pool table, couches and enough syrup-drenched pancakes, bacon and sausage to make you miss home. For other ex-pat Americans reading this, I found this article on ways to catch U.S. sports while overseas, of course nothing beats a Sling Media box.

On to the business at hand...
Last Thursday one of Lok Capital's investors, FMO-Netherlands Development Finance Company, was confirmed to have invested $2.4M in Bellwether (the first Microfinance Venture Capital fund in India).

Coupled with an additional $2.4M from existing investors Hivos-Triodos Fund (also of the Netherlands) and Gray Ghost Microfinance Fund out of Atlanta, Georgia, Bellwether is now up to roughly $14M if my notes are correct. While it's another nice announcement for the MF sector in India, it looks like Bellwether has had to scale back a bit from the additional $10M they anticipated raising last October.

To those of you experiencing wonderful winter weather in the States, I thought I'd let you know that the temperature in Northern India continues to improve. The fog and cold is gone, replaced by warm sunshine and blue...uh...smoke-filled skies.

Yunus: Indian MF Not Picking Up?

This past Tuesday, Nobel Peace Prize winner Mohammad Yunus spoke at the Federation of Indian Commerce and Industry where he told the audience that Microfinance has not picked up in India.

From what I gather in the news stories (I was not in attendance, but rather at a Private Equity Conference in Mumbai) Yunus was complaining that the private banks here have not been quick enough to make on-lending funds available to MFIs.

Unfortunately, on this point I think Mr. Yunus is a little out of the Indian loop. Many of the conversations we've been having with Indian commercial bankers suggest just the opposite. Although my anecdotal experience can't be taken as a definitive survey, most bankers that I know here who've done business with MFIs want to take more and more exposure. One bank we talked to even suggested that they were open to extending credit of up to Rs. 300 Cr. ($65 million) to a single MFI this year.

The bankers are telling us this because they are eager for us equity investors to get our money into the sector as fast as possible, so they can go on lending to these organizations and lever up our investments.

The repayment rates (and, most important, the recovery rates) that I've been seeing in the MFIs we look at have been on the whole pretty good, 95 - 97% for the established firms. In the newer start-ups, who are often trying new models and ways of lending, 90 - 95%. So unlike Mr. Yunus, I can't complain about the attitudes of the major private banks that we've dealt with here in India. But I will say that some of the banks seem to have been a little derelict in managing their duties. Their eagerness to lend to these institutions who, on the whole, are experiencing strong repayments and cash flows has left some additional due diligence work for the equity investors to do in their wake.

Nonetheless, banking funds are available here in India if your MFI has a track record and one or two significant equity backers. And that's where firms like mine come into the picture.