Finnovation

Indian Microfinance is Big Business, Now What?

By Mark Straub

To Save the Industry, It’s Time for Policymakers to Embrace Savings

One of the most fascinating subjects of the last quarter century for students of economic development must be the peculiar rise of microfinance as a venture capital-backed asset class, now poised to see multi-hundred million dollar initial public equity offerings in the next 12-18 months on the Indian stock exchange.  Well known giants of Indian microfinance who serve millions of clients – SKS, Spandana, SHARE and Bandhan – as well as upstarts Ujjivan and Equitas, have attracted millions in risk capital from top global venture capital firms and sovereign wealth funds, in several cases transforming themselves from non-profit NGOs to corporations in order to raise capital and attract top management talent. 

Collectively, the Indian microfinance sector raised over $500M in private equity last year alone.  With on-paper valuations of these companies in the hundreds of millions (dollars not Rupees!), and in at least one case over $1 billion, sales of founders’ stock in private secondary sales has created Hyderbadi millionaires seemingly overnight, something unseen in India outside of BPOs, Bollywood and corrupt politicians. 

There is a lot of froth in this market.  And while it is clear that the sector is receiving a bit of hype, it would be a mistake to overlook the fundamental shift going on in India’s economy, which microfinance both benefits from and is a manifestation of.  As India’s GDP continues to chug ahead above 6% despite a global recession and as optimism across the country soars following the first democratic reelection of a prime minister in 40 years, now is the time for the Reserve Bank of India (RBI) and the rest of India’s policy makers to address a key limiting factor that is perverting the development of the microfinance sector and preventing a healthy transition to “microbanking.”  The RBI should eliminate the ban on acceptance of savings by microfinance institutions, and expand its federal insurance program (the DICGC, similar to America’s FDIC) to include and protect savings deposits made by microfinance clients in microfinance institutions (MFIs).

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Why Savings?

Since coming to prominence in Bangladesh in the 1970’s, microfinance has primarily been about giving people loans.  However, as important as access to credit is, for both clients of financial institutions and financial institutions themselves, access to savings can be even more important.  As a microfinance borrower begins to develop discretionary income he or she needs a safe place to store it.  In poor and rural India that often means livestock, which are at risk of death or disease and are not easily liquidated, or gold, which can vary in value over time, carries additional metalworking costs and is not easily divisible.  The answer to this problem of savings is federally-insured deposits.

Moreover, as lending organizations grow in size, they must look for additional sources of capital to fuel their lending activities.  Borrowing money from banks is one way to source funds.   Another is raising private equity.  But the best way, the cheapest and most efficient way, is to collect and store savings from that bank’s clients.  Unfortunately the RBI and other regulatory bodies that govern microfinance in India today do not allow for-profit MFIs to accept savings from their borrowers.  Essentially, they are locked out of transforming into banks.  This limitation is the greatest weakness threatening India’s miraculous bottom-of the-pyramid story.

As India continues to grow, demand for savings will grow too, particularly among the poor, who were first overlooked by traditional banks when they asked for loans, and now are likely to be overlooked again when they ask for savings accounts.  Banks do not serve these clients well because they do not reach to the village green or the slum’s doorstop, precisely the places where MFIs thrive. 

In the absence of accepting savings or “thrift,” these lending organizations (known in Indian regulatory parlance as Non-banking Finance Companies, or NBFCs) inevitably look elsewhere for capital.  For the last three years, that has been large banks and international venture capital investors, the latter of whom require equity stakes in return for money.  These venture capital firms do bring plenty of value to this market (and in full disclosure, I worked for one in India). They do so by injecting large amounts of capital quickly, by demanding stronger, more transparent corporate governance from management, by introducing technology and global best practices, and by bringing legitimacy and attention to the sector. 

But venture capitalists alone cannot build microfinance into the industry it needs to be, an industry that serves all the financial needs of the country’s vast poor population.  Venture capital remains a cottage industry and it requires significant returns on capital to satisfy the long-holding cycles and high risk associated with its investments.  Client savings on the other hand requires much lower costs. 

ICICI, India’s largest bank, pays its depositors 5-7% a year on their savings balances.  In contrast, banks that lend to MFIs typically require annual interest rates of 12-14%, and venture capital funds generally target annual IRRs of 25% or more on their investments.  Among these options, venture money is the most expensive to MFIs trying to build their businesses, but venture investors have been some of the strongest advocates of this industry in India to date, and the most willing to take risk and put up the necessary cash to fuel growth.

Now is the time for this conversation because as the first crop of private equity-backed MFIs near exit in public markets this year, there are grumblings on blogs and in newspapers from industry observers and regulators suggesting that rates of return on invested capital in these MFIs should be capped.  That would be a recipe for disaster.  Were regulations introduced stipulating limits on how much could be earned on an MFI investment, panic among investors and the ensuing flight of capital would crush whatever good intentions regulators had, leaving MFIs and their clients stranded with few good options for financing.  Moreover, such a move would damage the growing stomach investors seem to be developing for India and confidence in its relatively poor, but promising, consumer base. 

A much better alternative is for the Indian government to finally unleash the flood of tiny deposits that many poor borrowers in India are so desperate to protect, by allowing MFIs to leverage their existing relationships with these borrowers and accept savings.

Mark Straub is a guest contributor.  He is an investment professional with the DFJ Growth Fund and previously worked at Lok Capital, a micro-finance investment fund in New Delhi.

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IDE WatSan in the Field: Creating a Market for Sanitation

By Vanessa Green

International Development Enterprises (IDE) is a leader in market-based solutions for rural poverty.  As a social entrepreneur in the water sector I looked forward to the opportunity to join eight of my finnovation peers on a field visit with the high-growth IDE Cambodia WatSan team.  We arrived at the IDE office just in time to pile into a van and head out to a village meeting where a sanitation education and marketing campaign was ongoing (see “Why Buy a Toilet”). 

IDE believes in creating markets for social products. The organization aims to be a catalyst for local social enterprises, “lighting fires and fanning the flame” with the goal of demonstrating the market for new social products.  To that end, the Cambodia WatSan team, lead by Cordell our guide for the field visit, plays three primary roles:

1. Identify a development need and use a human centered design approach (in collaboration with IDEO) to create an innovative social product - in this case, The Easy Latrine.
2. Simulate demand with education and social marketing - “Easy to make, easy to use, easy to buy” 
3. Generate supply by proving the model to local entrepreneurs in adjacent industries

The product development phase for the Easy Latrine is complete and local manufacturing has begun.  The human centered design approach led to a manufacturing process that is 2-3x more efficient than standard latrines and thus production is quick and cost effective.  Now, the 20 person IDE WatSan team is focusing on creating both supply and demand.  To do this, they first they provide sanitation education and training to local entrepreneurs (selected because of their existing business in concrete products). Once the entrepreneurs see the business opportunity in sanitation, IDE provides technical training on latrine manufacturing and installation as well as business accounting support (e.g., suggested price, MFI partners, labor/materials cost, profit).  Finally, the IDE staff markets the product to demonstrate demand.  Over time, IDE plans to transfer the social marketing know-how to the entrepreneurs so that the market can scale organically.

IDE’s market-based approach strengthens local capacity and innovative potential.  However, IDE struggles with the fact that market-based implementation can be slower and less efficient than the direct implementation approach used by other NGOs.  Furthermore, if IDE succeeds in creating a sustainable market for their products they effectively put themselves out of business, a risky pitfall for a donor supported organization.  That said, IDE’s work with the Easy Latrine clearly provides a strong model for effective social enterprise facilitation.  By designing a locally relevant product and stimulating both supply and demand in the market, IDE is effectively creating a new, sustainable industry for an important social good.

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IDE Social Marketing: Why Buy a Toilet?

By Vanessa Green

IDE WatSan (International Development Enterprises—Water and Sanitation) has developed a compelling social marketing approach that has driven rapid uptake, measured by total units sold.  The IDE team uses picture-based materials and hands-on activities to help open a discussion about the sensitive topic of human waste. 

The program starts with visits to each household where an invitation is given to invite the family to a village meeting on sanitation.  The invitation cards have two sides, one showing a happy family with a latrine and the other showing a sick family with no latrine.

The next day a village meeting is held and the invitation cards are used by IDE staff to map the village, highlighting location of households with latrines.  Next, community members are asked where they go to the bathroom today and sand is added to the picture to represent human waste (which ends-up covering most of the village).  The mapping is followed by an activity on the five contamination pathways and then a safe water demonstration conducted by adding human feces collected from the local village to bottled water.  After these activities and lots of engaging conversation between the villagers and the facilitator, attendees are asked to make a purchase commitment. At this point the local entrepreneur that will supply the villages is on hand to take orders.  

Despite IDE’s emphasis on sanitation education, the WatSan team has found that latrines are predominantly seen by villagers as a status symbol, not a health product.  The aspirational value of latrine drives purchase but may be counter to the goals of product adoption and correct use.  For example, IDE has seen some cases where the $30 latrine is bought but not immediately installed.   In these cases, the latrine could theoretically be installed immediately with a bamboo enclosure, but some households are waiting to save enough money to buy a more expensive cement brick enclosure that would maximize their status benefit. Given the emphasis on sanitation and health in the social marketing materials, this behavior seems counterintuitive; however, it clearly highlights the importance of incorporating local perceptions and drivers into all aspects of product development, marketing, and uptake expectations. 

To-date,  IDE’s strong social marketing campaign, supported by word of mouth and local social pressure have driven rapid growth in Easy Latrine sales, creating an initial Cambodian market for the product.  As the market grows, IDE expects that a tipping point will be reached both at the community and regional level, and the sanitation market will reach a point where it grows organically and sustainably, with latrine use as the new status-quo. 

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Storytelling in Phnom Penh

By Francisco Mira

From a 1 to a 2-needle machine

It’s 35 degrees Celsius, but it feels like 45. We’re riding a Tuc Tuc heading west of Phnom Pehn following one of AMK’s client officers to meet with Emro Saro. Emro is an AMK client who received a R800,000 (USD 200) loan 8 months ago to buy a sewing machine. Sou Chantrea, the client officer, loves to have her as his client as she has never missed a payment.

Emro’s age is hard to tell but I’d say she is somewhere in her 60s based on her stories on how she learned to sew in one of King Sihanouk’s factories. Her two grandsons run around the house while we interrupt her daily work. She does some small jobs for the local garment factory and thanks to her new machine, she can sell around 10 trousers a day providing her a steady income of R300,000 (USD 75) a month. Although she’s increased her income over the last year, she complains about her machine: it’s a one needle machine and it often breaks. In a few months, she’ll open a new loan with AMK and with her savings, she’ll buy a 2 needle sewing machine.

No. 182E – from guarapo to minimart

The next AMK client that we visit lives at lot 182E. Sadly, I’ve lost her name in translation… I’ll call her Channary.

In recent years, Channary was moved from her slum in Phnom Pehn to this new social welfare development in the outskirts of the city. She lives with her 16 year old son, a proficient painter in the 9^th grade. When she arrived in the new neighbourhood, she started a sugar cane juice business but wanted to have a MiniMart to increase her income and send her son to school. Several months ago, she met Sou Chantrea (the AMK client officer) and got excited with the loan opportunity. She immediately applied for a R800,000 loan and when she received the money, she stocked up in eggs, soft drinks, snacks, toothpaste, canned goods and all sorts of products. Thanks to her new business, she’s now selling around R80,000 a day and claims to have a 10-25% profit from her minimart.

Her boy shows up in his clean school uniform and he shows us one of his drawings while Channary proudly says that with the next loan that she gets from AMK, she’s going to start selling beer.

A few kids come by and buy some ice from Channary. We buy a few sugus and say goodbye and head back to the city. 

Finance at your doorstep

Angkor Mikroheranhvatho (Kampuchea) -  AMK started operations in 2003 as a separate microfinance institution from its parent company — Concern Worldwide Cambodia. After a couple of years expanding its market through most of the Cambodian provinces, in 2005, it reached its first annual operating profit. Due to its high coverage of the Kingdom of Cambodia, AMK incurs very high operating costs and very slim margins. This type of operation and continuous growth has only been possible thanks to inexpensive foreign loans from NGOs like Kiva and some European governments.

AMK’s mission is to help large number of poor in Cambodia through the delivery of viable microfinance services. And from 62K clients, 7 branches, and USD 5M in loans in 2003, to 225K clients, 7 branches, and USD 5M in loans in 2003, AMK has become one of the leader MFIs of Cambodia. AMK’s success is based on its high coverage and “finance at your doorstep” motto; AMK client officers can drive their motorbikes for days on remote villages gathering new clients and thus drawing together a ratio of 600 clients per officer.

Despite this success, AMK’s future seems very challenging yet exciting. With the soar of MFIs over Cambodia, frequent loaners have opted to access these institutions on larger scales and clients are now picking up loans from one, two or up to three different MFIs. As result, AMK is not renewing loans for clients with multiple loans and is just focusing on better loans and niche customers. Along with this specializing of loans, AMK is now planning to broaden its services within savings, insurance and money transfers. 

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Savings Practices @ the BOP

By Irvin Sha

As part of our course on Financial Innovation, our team worked in conjunction with Mercy Corps and Micra to look at what microfinance institutions (MFIs) around the world have been doing to stimulate savings amongst the poor.  Practically speaking, savings and loans are opposite sides of the same financial coin.  Both provide the poor with large lump-sums of money that they can put to work for special occasions, such as capital investments in businesses, weddings, education, etc.  Both require a series of semi-regular payments into a loan/savings pool.  The key difference from the consumer’s perspective is when they can expect that lump-sum to be available to them.  For loans, the sum is available prior to the payment stream, whereas for savings, it is only available at the end.
 
Most MFIs have concentrated on the loan side for a number of reasons.  First and foremost, most have taken the view that the poor simply do not make enough to save.  Secondly, most of the innovations to date – e.g. Grameen style joint liability programs – have been around loan repayment.  Lastly, and perhaps least frequently mentioned, is that loan programs have so far tended to be far more profitable than savings.  As a consequence of this, micro-savings programs for the poor have been largely left as ancillary products attached to MFI loan programs. 

But none of this means that the poor do not want to save, as illustrated by the following quotes taken from a MicroSave study in East Africa:

• If I had some kind of insurance or pension plan I could be saving for my old age. As it is, I give money to my brother in the village to buy goats and cows. Whether he’ll look after them for me, and whether he’ll pay me in the end, only God knows. 
• You ask us ‘what do we do when we are too old to work? I’ll tell you what the answer is – we pray to die.
• When my mother was still alive I used to give her a few shillings every day, kept back from the housekeeping money. She looked after it for me really well, and every January there was always enough for the school fees. Now she’s dead I just haven’t got anyone I can trust like that. It’s much harder to make sure I’ve enough for the fees. We may not be able to send our youngest to school this year. 

Lacking institutional savings mechanisms, the poor have typically relied on informal savings mechanisms, such as hiding their money, buying livestock, or giving their money to friends and family for safekeeping.  These mechanisms are typically fraught with risk.  In one account, a man who had been hiding his money under his mattress for years woke to find that much of his savings had been consumed by rats.  Such accounts are more the norm than the rarity, and typically lead to losses of ~20% on average.  In the face of this, many of the poor have demonstrated a willingness to sign up for savings accounts with essentially negative APRs, for lack of a savings mechanism of comparable security.
 
In some ways, the holy grail of micro-savings products is a product that effectively replicates the convenience of Western savings accounts, but at a sustainable cost.  This is more difficult than it sounds; whereas a loan officer can be reasonably confident that he won’t have to visit his clients except on repayment days, the needs and timing of a savings client are significantly more volatile.  To mitigate this, micro-savings programs generally impose some combination of restrictions on their programs.  These include:

• Deposit size – The MFI may require a fixed or minimum deposit size in order to ensure that it can recoup its processing costs
• Deposit frequency – MFIs may restrict deposits to a daily, weekly, or even less regular basis
• Withdrawal restrictions – Many savings products only permit periodic withdrawals, or may lock the savings up until the occurrence of certain events (e.g. reaching a certain amount in savings, repayment of an MFI loan, or a pre-defined event such as a marriage)
• Loan bundling – MFIs may only offer savings as part of a packaged deal with one of its loans; in these cases, savings are typically held as collateral against the loan
• Joint liability – Typically seen in loan-bundling situations, the savings account may be part of a joint liability program, in which the default of one member of a group may lead to the loss of the other members’ savings

Depending on how these restrictions are structured, they may or may not raise the cost of saving to the point where a savings relationship with the MFI may become unpalatable to the poor.  
 
That being said, strides have been made in the last decade to overcome these problems.  As with loans, some of the most interesting work in the area has been done in Bangladesh.  SafeSave, co-founded in 1996 by savings pioneer Stuart Rutherford, has done a great amount to alleviate some of these difficulties in the slums of Dhaka.  SafeSave’s core program eliminates most deposit, withdrawal, and joint liability restrictions, and yet still manages to be profitable.  Moreover, through a series of pilot programs in the rural Hrishipara region, SafeSave has continued to examine alternative ways of offering economically sustainable savings programs to the poor.
 
In addition, many savings programs have tried various innovations to make their programs more attractive and more affordable.  Incentives have included lotteries, member discounts, and even stickers for little children.  In the Dominican Republic, a soap opera with savings as its central theme was funded in order to firmly implant a savings mentality into the popular culture.  Perhaps the most exciting advances have been made in the mobile savings space, with M-Pesa and its 8.5M customers leading the way.

Although perhaps less inherently sexy than the typical MFI loan program, savings products are still in very strong demand amongst the poor. Economically sustainable means of satisfying this demand exists.  Whether or not they gain traction is an open question.

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Ashoka Peace Features MIT Sloan Finnovation

“With an estimated 3200 NGOs in the country, I am told that Cambodia has the second highest saturated “NGO market” per population in the world after Rwanda.  In a country that has suffered from genocide and is just beginning to experience a growing vibrant civil society, it is helpful to see how organizations are choosing to frame problems and solutions and the influence of conflict on decision-making in communities.”

Finnovator Priya Parker discusses our visit with Hagar International in Phnom Penh for Ashoka Peace.  See the full post here. 

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Report from the field: Promoting Savings in Indonesia

By Andrew McCarthy

The developing world wrestles with how to promote a savings culture and develop a system of widespread delivery, and Indonesia is no exception to this conundrum. With roughly 60% of Indonesians saving through informal channels or not saving at all, the question revolves around how to deliver a formalized savings product to an archipelago of over 17,000 islands in a cost-efficient manner.  

A team of four Finnovators explored this issue with representatives from Mercy Corps and Maxis, over two days in Jakarta through a combination of meetings with the CEO and regional director, a visit to the field, and concluded with a presentation given by the Finnovators on other savings methodologies from around the world.

Through our research, we broke savings innovations into four primary buckets: Product, Process, Promotion, and Policy (a.k.a. the four P’s). Product innovations split into deposit-side and withdrawal-side tools to promote greater savings. Process innovations revolve around system design and enhancement of the delivery of savings products. Promotion revolves around supporting education and awareness. Policy innovations in savings are through government intervention to change the regulatory framework.

Our takeaways:

• Savings in Indonesia is usually tied with a loan. Part of the loan terms dictate that a certain percentage of the loan be put into a savings account or accrued over the course of the loan. At one particular BPR (rural bank), this type of forced “savings” accounted for ~90% of all deposit accounts.

• Mobile banking is not a panacea. Bank Indonesia (BI), the regulatory body, is very conservative and restrictions currently prohibit rollout en-mass of mobile banking with the same level of services as other countries (for example: KYC restrictions are greater, P2P transfers require a license, agent network cannot deliver banking services, etc.)

• Education is critical. The developing world has typically experienced shocks to their financial system, causing distrust among citizens of banks and formal institutions outside their immediate control. It should be the goal to educate citizens of the benefits of not only savings, but also savings through formal institutions.

• There is hope. Savings rates are ever increasing and with the continued work of people on the ground to educate and innovate savings methods, they will continue to increase.

On behalf of our Finnovation team, we would like to express our deep gratitude to the Mercy Corps / Maxis team for their time and support. This project has been an invaluable learning experience for our team to understand savings in the developing world. We all look forward to watching the fruits of your labor turn into increased savings rates and the alleviation of poverty in Indonesia.

The Finnovation Team: Andrew McCarthy, Lisa Frist, Mercedes Politi, Irvin Sha

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The Role of the Press in Cambodia: Meeting with The Cambodia Daily

By Megan Wilbur

On March 17^th a small crew from Finnovations visited The Cambodia Daily, an English language newspaper based in Phnon Penh.  There we spoke with the editor-in-chief, Kevin Doyle, who gave us a candid account of media, business, and politics in Cambodia.

The Cambodia Daily was established in 1994 with the mission to provide Cambodians with unbiased local and international news.  The paper is marketed to educated Khmers and ex-patriots, and has a circulation of about 8,000 in 14 provinces around the country.  Doyle explained that even though he is free to print whatever content he chooses, the government is always watching closely.  He receives regular warnings from officials and even spent a few days in jail after reporting stories the ruling party deemed inappropriate.  Nonetheless, print media in Cambodia enjoys relative freedom compared to broadcast media, which is completely controlled by the government.

Perhaps the most interesting discussion we had with Doyle was about the government, politics, and future of the country.  In 2001, the Cambodian People’s Party (CPP) solidified control of the state and began pursuing a strong-handed governance strategy based on the Singapore Model.  At the same time, opposition political parties lost momentum as the vast majority of Khmer decided the best way to ensure national peace and their personal prosperity was to support the CPP’s agenda. Dolye said that while the government attempts to implement any and all policy to spur economic development, they are not focusing on issues of poverty and education during this phase of their development.

The discussion with Kevin gave our group a different lens with which to view Cambodia while also leaving us with more questions:

·      Are semi-authoritarian regimes the most effective form of government for developing countries?

·      What will economic development look like in Cambodia?  Will it continue to be dominated by foreigners or will there be a Khmer entrepreneurial class? 

·      Will the government complement their economic development strategy with social sector policies that help alleviate poverty and create an educated middle class in the long term?

·      Finally, will youth under 25, who represent 60% of the population, grow up questioning the CPP and pushing for political change and less corruption?  

Only time will distinguish the winners and losers in Cambodia’s economic development and it will be interesting to watch as this country continues to rebuild and leave tragedy behind.

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Venture Incubators + Social Entrepeneurship = Development?

By Karan Singh

The last few years (and particularly the last six months) have brought news of incubator-like groups starting across the US — Y-Combinator (SF Bay Area), TechStars (Colorado, Seattle), The Founder Institute (New York, DC), and Excelerate Labs (Chicago) to name a few. If you aren’t familiar with the model, check out this brief trailer from The Founders Institute.

In many ways, these groups are financial innovators. They enable business activity through seed capital (generally less than $20,000) and mentorship. They bring together successful (and often serial) entrepreneurs and investors with an interest in providing guidance and support.

Traveling through Cambodia and Indonesia this week, I imagine these groups could be a powerful force to foster social entrepreneurs and economic development abroad. Having grown up, gone to school, and worked in Silicon Valley, I’ve seen how powerful an ecosystem system can be in connecting the right players and promoting best practices in innovation (experimentation, iteration, data-driven decision making, etc.). Before business school, I worked to create a corporate incubator to promote “intra-preneurship” and am a firm believer in the power of creating intentional clusters to create a value around and support for innovation.  

While still early, this model has proven to be a powerful force in the US. I see real challenges, however, in applying the model as it exists now to the developing world context. A few that come to mind: 

First, the three month runway for most programs may be enough for an internet-based product or service that can prove success quickly, but not enough time for other sectors. It can often take more than three months just to set up the infrastructure of a program or business in the developing world (the World Bank’s Doing Business In reports nicely illustrate this process across a number of geographies).

Second, incubators create and promote founders, often placing them on a pedestal at the expense of middle management. New ventures may struggle to scale as they search for management to attract the right talent and build out the team. We’ve heard from a number of CEOs and country directors this week in Cambodia that they struggle with finding talent for middle management roles in the labor marketplace.  

And finally, third, the stakes are high. While we expect one out of ten businesses to fail in the US, there isn’t the same expectation in the developing world — there just isn’t the same capacity to absorb risk.  If a new restaurant fails in San Francisco, the owners lose out, some customers are disappointed, but the entrepreneur can shift resources and try again. In places like Phnom Penh or Port-au-Prince, if an entrepreneur fails, not only is that individual much more devastated, the clients he is trying to serve often don’t have other options from which to receive that product or service. This reality may call for more “responsible innovation” — though it’s not clear what that looks like.

I am interested in exploring the topic further. I think the model can be adapted to emerging markets, but some key questions will need to be considered and worked through: 

• When the stakes are high and one is working in development at the BOP, what does “responsible innovation” look like?
• How does one decrease risk in an inherently risky space? 
• How does one groom talent not only at the top, but also at the middle and bottom? 
• Are there ways to form more community-based or group-based innovation incubators?

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