How things change. Less than two months ago the Indian Microfinance industry was riding the crest of a wave, and excitement was palpable among industry stakeholders. Today, the sector is under attack, the almost miraculously reliable flows of repayment down to a trickle, and that of institutional credit virtually dry. And yet, we believe – maybe we are counter-intuitive investment advisers, maybe we are simply incorrigible optimists – that the sector could be on the point of return to a better balance between its commercial and social bottom-lines: a Third Wave.
Microfinance in India has roots in decades-old structures of informal and community financing, and more recently in chit funds and the SHG-Bank Linkage programs. But the modern private microfinance institution (MFI) operating on the Grameen/JLG model has evolved primarily in the last 10 years. The first half of the decade was an unmitigated struggle for them, dominated by not-for-profit NGOs and focused largely on social impact and sustainability via funding from Foundations and DFIs. In the last five years, the sector – or at least the news – has been dominated by for-profit NBFCs, with a focus on rapid growth and scale, fuelled by huge amounts of capital from PEs and backed by professional management.
These phases are what we would refer to as the first and the second wave of Indian Microfinance. The current crisis, triggered by the AP Ordinance, has helped everyone realize that neither a bullock-cart nor a Ferrari is appropriate, and in the real world one needs to find an appropriate balance.
If the sector tides over the current crisis, in the next few months we could see a Third Wave of Microfinance evolving with this balance. Investors with a deep understanding of the drivers and risks of this sector, we firmly believe, should view the current period as the second inflexion point for the sector, and as an excellent opportunity to make ‘value’ investments and ride on this Third Wave.
It is incredible how events in a few months have changed perceptions of an entire sector. A year ago, VC/PE investors who had not made an investment in the microfinance industry felt left out, and rued missing the bus. The SKS IPO – the first in the Microfinance sector - was around the corner and everyone in the financial markets was waiting with bated breath. We were fielding calls from people who had forgotten our existence, wanting to spend time understanding the microfinance business. We spent even more time meeting people at all levels from other NBFCs, the Retail Banking sector, and Business schools, all of whom were stumped by the simplicity of the Microfinance model.
A year later, the sector has become one of the most maligned and viciously attacked. The build-up to the SKS IPO saw a number of debates not only on the merits of a ‘social’ organization (with an intended mission of alleviating poverty) accessing the capital markets, but also on the ethics and morality of stakeholders who realized financial gains before the listing. Meanwhile, the growing flow of capital into the sector fuelled a seeming mania for higher valuations that overtook the customers’ needs. The post-listing euphoria was cut short by the unceremonious firing of the SKS CEO, and threw up a host of issues around corporate governance and transparency.
Finally, the linking of suicides in AP to over-indebtedness and coercive practices led inexorably to the AP Ordinance and the current crisis. The founding father of the Microfinance industry in India, the still redoubtable Vijay Mahajan, has spoken about ‘an imminent collapse of the industry’, ‘death of the Microfinance model in its current form’ and ‘a lot of things not [being] right about the sector'.
As an eventful 2010 draws to a close, murmurs are still audible about some of the largest companies in the sector being on their death-beds. However, there is an increasing sense that the dust is beginning to settle, at least from a media attention viewpoint. It may take a few more months of coordinated effort to tide over the liquidity crisis, and several months of introspection and intellectual sweat to evolve the model for the next stage, but there is sufficient evidence on the ground to suggest that Microfinance as a business is here to stay, albeit with significant changes in strategy and business models.
In the first wave of Microfinance, promoters were central to the success of the organizations (mostly NGOs) and creating a social impact on the ground was the key focus. In the second wave, the focus was on the organization, with investors infusing huge amounts of capital and professional implementation of systems and processes with the objective of achieving growth and scale. In our view, we could now see the birth of a Third Wave, with the client at the center of the model, and everything that the Promoter or the Company does driven by her needs.
In this model, we expect to see many client-centric innovations. Organizations are likely to develop a product portfolio that consists of a far wider offering than the “any-color-as-long-as-it’s-black” Grameen product (Customizations to cash-flows of the client? Partnerships for non-financial products?). Operating and delivery models should see plenty of redesign (JLGs and centers giving way to individual lending? Banking Correspondents operating with MFIs?), and credit-appraisal systems will be strengthened and formalized. All of this will eventually lead to a range of services being offered to the client (both financial and non-financial), based on a more complete understanding of the needs of the end-customer, and more sophisticated service offerings and transaction types. Delivering these improved services will require significant changes in the way data is captured and mined.
The current transition period presents, we believe, a tremendous opportunity for those investors who wish to come in at attractive valuations and ride on this Third Wave. Investors in the sector during this period are likely to reap rewards that provide a far more equitable balance between generating financial returns and having a real positive social impact on the client, her communities and the country. Now that is something worth investing in.
(Atreya Rayaprolu is a Vice President at Intellecap and K Sree Kumar is the CEO of Intellecap, a leading Indian social business advisory firm that has intermediated over $120 million investment in the social sector.)