Michael Chu Fsf2011

Microfinance: Today and Tomorrow
Michael Chu Harvard Business School MICROFINANCE: INCLUSION & SUSTAINABLE BUSINESS Financieros sin Fronteras IE Business School, 22 February 2011
Michael Chu, Harvard Business School
Copyright President & Fellows of Harvard College.
Microfinance
1.
Financial services for the base of the socioeconomic pyramid (BoP)

Traditionally: working capital loans & savings Today: All (incl. housing, remittances, insurance)
2.
BoP: 4.0 billion of worlds 6.4 billion people
Individuals earning ~$3,000 or less a year 1 Billion 1.4 Billion Microfinance Sweet Spot: C, D, E+ Approx. 3.25 Billion 1.2 Billion 1.6 Billion 1.2 Billion Base of the Pyramid
1
Microfinance: An Industry 4 Decades in the Making

1.
1970s: First microfinance loans & Experimentation

1970: Bank Dagang Bali - Indonesia 1971: Opportunity International Colombia 1973: ACCION International Brazil 1976: Grameen Project Bangladesh
2.
1980 1990: Leading NGOs Break Even
Scale from challenge turns into a friend Growth explodes: ACCION Network in Latin America 1983: Grameen Bank established under special law 1984: BRI (Indonesia) converts to commercial microfinance 1984: ACCION Bridge Fund: tapping into banking sector
3.
1990 2000: Regulated MFIs: Tapping into Capital Markets

1992: BancoSol Bolivia, followed by FFPs: Caja Los Andes 1998: Mibanco Peru 2000: Compartamos Banco - Mexico
2
Why does Microfinance Matter?
LACK OF INCOME
POVERTY
3
Majority of Worlds Income is Earned in the Informal Sector
INFORMAL SECTOR Income of >70% of Economically Active Population of the World

(OIT, 2002)
INCOME
POVERTY
4
Financing the Informal Sector
MONEY LENDER
INFORMAL SECTOR = Income of >70% of Economically Active Population of the World

(OIT, 2002)
INCOME
POVERTY
LAST LINK DISTRIBUTION
5
Microfinance: A Response to Traditional Sources of Funds
STRETCHES INCOME
MONEY LENDER
EXPANDS INCOME
MICRO FINANCE
INFORMAL SECTOR = Income of >70% of EconomicalLy Active Population of the World

(OIT, 2002)
INCOME
POVERTY
INCREASES INCOME
LAST LINK DISTRIBUTION
6
Economic Fate & Citizen Empowerment are Linked
STRETCHES INCOME
EXPANDS INCOME
MICRO FINANCE
INFORMAL SECTOR = Income of >70% of EconomicalLy Active Population of the World

(OIT, 2002)
INCOME
POVERTY
INCREASES INCOME
BASIS FOR CIVIC RIGHTS 7
Higher Income: Access to the Key Drivers of Better Futures
HEALTH CARE STRETCHES INCOME EDUCATION EXPANDS INCOME POVERTY SIGNIFICANT IMPACT HOUSING
MICRO FINANCE
ADDITIONAL INCOME
INCREASES INCOME
BASIC SERVICES 8
Microfinance Today: Part of the Financial Sector

1.
2000 2010: IPOs - Publicly-traded shares in stock exchanges
Strong microfinance component 2003: BRI Indonesia 2006: Equity Bank Kenya Pure microfinance 2007: Compartamos Banco Mexico 2010: SKS India
2.
Industry Scale:
Institution BancoSol Mibanco Compartamos
No. Clients (000) 146 581 1,900
Loan s ($MM) $ 435 $1,306 $ 750
Grameen
SKS
3.
8,300
7,700
$ 956
$ 980
Mainstream:
$1 billion overhang in funds raised to invest in microfinance

9
Yet Microfinance Penetration is Just Beginning

1.
Families Reached: Approx. 150 MM Active Clients - Credit
Loan portfolio: Approx. $45 billion to $60 billion
2.
Just the basic product: Working Capital loans

Savings lagging Other financial products & services just beginning
3.
Just the easiest to reach clients
Remote rural areas lagging
4.
Total Market Basic WK Loans : Approx. 545 MM families - $272 billion

Est. C, D, E+ segments: 3.25 bilion, @ 4/family = 813 MM families Assume 2/3 are potential credit clients: 545 MM families Assume potential: $500/loan
5.
Basic WK Loan Penetration:

No. of Active Clients: < 28% Portfolio Volume: < 20%

10
Multitude of MFIs, but Industry defined by Leaders

Of the 150 MM Active Clients, 130 MM are served by less than 90 MFIs By and large, they are commercial, regulated financial institutions Leading MFIs Regulated
Efficient Self-Sustaining High Returns Most profitable Most Solvent High Growth National Banking/ Financial Authorities
Financial Investors
Corporations
Capital Markets
Financial Instruments
Public
Deposits
Market: Base of the Pyramid

Financial Services
Large: significant volume

Growth segment Sustainable asset quality
11
Today: Rapid Change Continues Unabated

Major M/F markets: All key factors behind success of incumbents are in flux:
1.
Heightened Competition

Conventional banks are entering the market - Peru: 44 of 55 institutions regulated by Bank Superintendency are in M/F New players from non-banking origins - BoP retail chains, with consumer finance base Developed microfinance ecosystem - M/F expertise and infrastructure becoming readily available Globalization: National boundaries no longer barriers - Global players & international expansion of MFI leaders
2.
Technology

Front office: e.g: non-bank branches, mobile payment systems Back office: redefinition of scale beyond local markets, new methodologies
12
The Promise of the Future

1.
Competition & Technology: Together, finally solving the M/Fs paradox:
Financial Svces at very ToP and at BoP share same approach: High Touch Banking
2.
Going from todays 150 MM clients to tomorrows 500 MM:

From a high-cost to a low-cost operating platform, while preserving asset quality Expanding the reach of the front office while concentrating processing to maximize economies of scale of the back office
3.
Tomorrow: Models that disrupt todays microfinance establishment
Just as todays models disrupted yesterdays traditional banking
4.
Holy grail: from high touch to no touch

Radical reduction in costs Quantum leap in pricing and coverage
13
The Threat of the Future

1.
Todays high visibility of microfinance: High Numbers Reached

1st & 2nd Decades: NGOs, development donors, philanthropy: do-gooders 3rd Decade (1990-2000): M/F banks under bank regulation: credible numbers 4th Decade (2000-2010): Finally, numbers that make M/F relevant in national development
2.
High numbers are essentially the result of commercial microfinance

Large, commercial institutions deriving profit from serving low-income populations: Combustible political mix Government oversight is unavoidable - Debate unlikely to be restricted to financial sector regulatory circles
3.
Regulatory oversight of Microfinance: Essential

Markets without regulations: The Jungle Positive regulation: M/F thrives to the benefit of all parties, especially the clients Negative regulation: Can push M/F back to 1st and 2nd Decades
4.
How serious is the threat?

Compartamos Banco (Mexico) SKS (India)

14
Microfinance: The case of Compartamos Banco

1.
1990: Initiative of a social NGO
Initial operations in Chiapas & Oaxaca (rural)
2.
2000: SOFOL Compartamos

Single purpose regulated finance company: microfinance Partners: Compartamos NGO, ACCION, Profund, private Mexican investors
3.
2002: First bond issue 2006: Bank: full-banking license
4.
15
Microcredit loans to rural population 93% of loans

1.
Group loans to rural women

From 12 up to 50 women Served by Compartamos Promoters (loan officers) 3 training sessions before disbursement
2.
Self-administration
Members indicate amount to borrow & save/week Elect leadership of group
3.
Weekly meetings with Compartamos

Group treasurer collects payments & deposits Shows Promoter slips of prior weeks payments and deposits
16
The IPO of Compartamos Banco

1.
At December 31, 2006

National coverage (29 of 32 states) Active clients: 616,528 (Growth rate: ~50% / year) Loan Portfolio: $217 MM, average loan size: $446 Asset Quality: Portfolio at risk > 30 days: 1.1%, loss rate: 0.6% ROE: 56%
2.
IPO in Mexican Stock Exchange: 19 April 2007

Secondary offering of 30% shares 13x oversubscribed by institutional investors in USA, Europe & Latin America Market capitalization: $1.5 billion
3.
IRR at IPO: > 112% compounded annual return
Initial investment in 1998: $6 million
4.
Friday, 18 Feb 2011: Market Cap: $3.25 billion
17
SKS
1.
1997: NGO established by Vikram Akula 2005: Converted into a for-profit
2.
$1.6 MM from individuals and social impact investors (Unitus, SIDBI)
3.
2007-2009: Commercial Investors
2007: Sequoia US VC firm: $11.5 MM 2008: $37MM 2009: $75 MM Sandstone US/India VC firm buys 12% stake
18
Michael Chu, Harvard Business School With thanks to Prof. Shawn Cole, Harvard Business School
SKS Growth
Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Assets (USD) 45,177 103,338 116,045 508,567 1,387,165 4,089,187 9,130,883 26,811,799 78,797,574 336,831,099 596,162,206 897,871,054 980,000,000
Borrowers 19 191 1,068 5,080 11,127 24,799 73,635 172,970 513,108 1,629,474 3,520,826 5,795,028 6,780,000
19
With thanks to Prof. Shawn Cole, Harvard Business School
SKS Performance
INDICATORS
Portfolio Growth FY 08-FY 09 Portfolio CAGR Last 5 Years Portfolio At Risk 30 Days Portfolio Yield Debt to Equity ROA ROE
SKS FY2010
54% 166% 0.40% 25.7% 3.2 5.0% 22.0%
Source: CGAP, based on MIX & SKS
20
SKS IPO
1.
July 28 to August 2, 2010: Issue shares for $350 MM

Primary (New shares): Secondary (Existing Shareholders):
$155 MM $195 MM
2.
Anchor Investors:

JP Morgan Morgan Stanley ICICI Prudential Quantum Fund
3.
Underwriters: Citigroup, Credit Suisse, Kotak Mahindra Market Capitalization: $1.5 billion
4.
21
Andhra Pradesh (AP) Crisis: The Setting

1.
The home state of the leading Indian MFIs

2009 Data Institution SKS Spandana SHARE BASIX Clients 5,795,028 3,662,846 2,357,456 1,114,468 Portfolio ($ MM) $960.8 $787.3 $490.9 $223.2 Global Rank (By Clients) 4 6 7 14
2.
Co-existing with extensive AP Government Self-Help Group M/F Program

Little or no threshold other than SHG membership to borrow Below market rates, high use for consumption vs microenterprise Tied to Government rural bank (NABARD) and Priority Sector Lending (PSL) Extensive local politician involvement
22
Source: Prof. Shawn Cole, Harvard Business School
The Road to the 2010 Crisis

1.
August 2: SKS IPO
Oversubscribed 13x, valuation $1.5 billion
2.
August 9: Reserve Bank of India expresses concern over high rates Fall: Press stories: Suicides attributed to microfinance debt October 15: Andhra Pradesh State Government Microfinance Ordinance

3.
4.
All MFIs must register with State within 1 month, with local district officials Government has no obligation to register, may cancel registration at any time Refund of any payments > 200% of initial amount disbursed o In practice, no MFIs charged such high rates All collections must take place in a local government HQ o Inconsistent with MFI business practices o Later revised to public places
23
Michael Chu, Harvard Business School Source: Prof. Shawn Cole, Harvard Business School
The Debate
Critics Allegations
1.
MFI Response
1.
MFIs: Usurious rates
Crisis: Invention of local media

Vs Govt SHG Program: 3%
2.
MFIs poaching SHG clients

Owned by opposition parties Local political issues Ordinance: result of political crisis
SHG: tiny amounts Slow processing
2.
No suicides actually linked to M/F
Prior allegations of suicides:
3.
MFIs encourage multiple loans MFIs: Coercive Collection MFIs: Focus on growth
3.
Bank loans, droughts, floods, highyield cotton, and microfinance
4.
No systematic rise of M/F suicides
As M/F has spread
5.
24
Since the Ordinance

1.
AP High Court refuses to stay State Govt Order (Oct. 22)
Permits collections for one week
2.
Central Government Finance Minister: MFIs should self-regulate (Oct. 26)
Central Government generally supportive of MFIs
3.
SKS holds meetings in only 59% of AP centers (week ending Oct. 29)
4.
Largest MFIs agree to cap rates at 24% (Nov. 3)

Response of Indian Central Bank (Reserve Bank of India-RBI):
5.
Microfinance: No longer a isolated niche - Conventional banks have M/F exposure: PSL portfolios - SKS: Publicly listed financial institution The RBI Board establishes Malegam Commission (Oct 15)
25
Malegam Comm Report Jan 2011 Main Recommendations

1.
Microfinance: Separate category with its own regulations Best Practices:

2.
Transparency Code of Conduct Credit Information Bureau
3.
Pricing Caps:

Overall maximum interest rate: 24% Margin Caps: 10%-12%
4.
Product Design

Maximum Amount of M/F Loan: Rps 25,000 ($550) Obligatory tenors: Rps 15,000 ($330) or less: 12 months, with voluntary prepayment at no fee Above Rps 15,000: 24 months, with voluntary prepayment at no fee No collateral
26
Evaluating the Malegam Recommendations

Positive:
1.
Thoughtful, analytical and well-researched: Some key best practices Interest Rate Caps: Set at levels that allow better MFIs to survive
2.
Negative:
1.
Mandated price and product design: Punish best performers (MFIs & clients)

Clients: cannot fund success beyond $500/loan or recognize build-up of assets No reward for better due diligence or analytical skills, innovation or segmentation
2.
Perverse unintended effects

Price caps punishes outreach to poorer and more rural clients Margin caps protects incumbent, dissuades new entrants Reduced flexibility makes disruptive models very difficult
27
Fundamental Issue: What is the role of Profits in M/F?

1.
Theme of this conference: Sustainable Business & Social Impact

M/F as a vibrant business: easy to understand No different than any other business
2.
What is the relationship between commerce & social value?

Less well understood Lack of wide consensus as to the right measures Without measures: weak accountability
3.
At the core are two radically different interpretations
28
Direct Trade-off: High Commercial Returns & High Social Impact
High
C O M M E R C I A L
R E T U R N S
Low
SOCIAL VALUE
High
Rationale:
1.
High commercial returns are made possible by high prices Key to social value is price; the higher the price, the lower the social value
29
2.
Clear & Direct, but Deeply Flawed

1.
Commercial returns are the function of 3 key management levers:
Only one of which is affected by price (ROS): Net Income Revenue Total Assets Net Income ROE = --------------- X ----------------- X ------------------ = ---------------Revenue Total Assets Equity Equity (ROS) (Asset Turn) (Leverage) (ROE)
Accordingly, ROE can increase while price falls so long as it is more than offset by Asset Turn & Leverage (efficiency in the use of assets and capital)
2.
Social Value: Solely a function of price if only current clients are concerned
But if impact is defined systemically, then it must be measured in relation to: - the target population as a whole: those served and those still unserved - Through time: not just now but what will happen in the future This is especially true in microfinance, when only 150 MM of 540 MM people are served
30
Definition of Success for Social Programs: BEST

1.
Best: The most effective option Economical: At the lowest price for the end-user Solidarity: For all those that need it Today: As urgently as possible
2.
3.
4.
This applies to all social interventions, and M/F is no exception.
31
Achieving the full potential of society
What to do is, by and large, known and simple
HEALTH CARE
EDUCATION SOCIALLY SUSTAINABLE SOCIETY
BEST: TRANSFORM THE LIFE CHANCES OF THE PEOPLE
MICRO FINANCE
ACCESS BY ALL TO
HOUSING
The challenge is to make it available to the majority of the world
BASIC SERVICES
32
To achieve BEST: S2E2
SCALE
HEALTH CARE
EDUCATION SUSTAINABILITY TRANSFORM THE LIFE CHANCES OF THE PEOPLE MICRO FINANCE ACCESS BY ALL TO SOCIALLY SUSTAINABLE SOCIETY
HOUSING
BASIC SERVICES
33
To achieve BEST: S2E2
SCALE
HEALTH CARE
EDUCATION SUSTAINABILITY TRANSFORM THE LIFE CHANCES OF THE PEOPLE CONTINUOUS EFFICACY HOUSING MICRO FINANCE ACCESS BY ALL TO SOCIALLY SUSTAINABLE SOCIETY
CONTINUOUS EFFICIENCY
BASIC SERVICES
34
The war against poverty since WWII

The major warriors, fighting at their best
1.
NGOs: Give birth to ideas that can

change the world
None of them, individually or collectively, are structured for scale
2.
Philanthropy: Nurture those ideas so they develop
or sustainability
3.
Developmental Agencies: Support those ideas so they can be fieldtested
National scale & a measure of permanence, but not structured for continuous efficacy or continuous efficiency
4.
Governments: Take the proven ideas that are most promising and deploy them nationally
cannot provide simultaneously and consistently what is necessary to win.

35
Delivering S2E2: Business
SCALE
HEALTH CARE
EDUCATION SUSTAINABILITY SOCIALLY SUSTAINABLE SOCIETY
PRIVATE ENTERPRISE
CONTINUOUS EFFICACY
MICRO FINANCE
ACCESS BY ALL TO
HOUSING
BASIC SERVICES
36
But not through one single enterprise but an Industry
SCALE
HEALTH CARE
EDUCATION PERMANENCE SOCIALLY SUSTAINABLE SOCIETY
VIA INDUSTRIES
CONTINUOUS EFFICACY (NOT FIRMS)
MICRO FINANCE
ACCESS BY ALL TO
HOUSING
BASIC SERVICES
37
The Social Role of Profit and Industries

1.
The only way to create an industry:

A commercial activity Above average returns This is the social role of profits
2.
Making markets work for the BoP
Competition is the only way to guarantee through time that the value-added created by a commercial approach flows not only to investors and managers but to the customers at the base of the pyramid This is the social role of an industry
38
BancoSol (Bolivia)
Interest Rates 2000 - 2010
Average Weighted Interest Rate Loan Portfolio
0,3
0.284
0,28 0,26 Interest Rate

0.240
0,24
0.230
0.221
0.211
0,22
0.217 0.212
0,2 0,18 2000 2001 2002 2003 2004 2005 Year
0.198 0.203 0.198 0.197
2006
2007
2008
2009
2010
Source: BancoSol Michael Chu, Harvard Business School
39
Bolivia Microfinance Industry: The Lowest Interest Rates for the BoP in Latin America
Dec 1998
Dec 2010
Source: Asofin
40
An Empirical Observation: High Commercial Returns Can be Integral to High Social Impact
High
C O M M E R C I A L
R E T U R N S
Low
SOCIAL VALUE
High
Rationale:
1.
High commercial returns create industries Industries produce S2E2 to ensure BEST for the Base of the Pyramid
41
2.
Microfinance: Today and Tomorrow

Michael Chu Harvard Business School MICROFINANCE: INCLUSION & SUSTAINABLE BUSINESS Financieros sin Fronteras IE Business School, 22 February 2011
Copyright President & Fellows of Harvard College.
A Reflection on Randomized Evaluations in Microfinance

Randomized clinical trials Origin: Medicine, e.g. penicillin
1.
Microfinance
Single solution: vs infection Bulls-eye metrics: evol. Infection Uniform: penicillin = penicillin Generalizable Random sample OK Timeframe appropriate
1.
Poverty: multiple interventions Working Cap, PPE, Housing Heterogenous: MIF A MIF B Segmentation Targeted selection: Key 12 to 18 Mos: 2-3 6-mo. loans
2.
2.
3.
3.
4.
4.
5.
5.
6.
6.
42

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Microfinance: Today and Tomorrow

Michael Chu, Harvard Business School

Copyright President & Fellows of Harvard College.

Financial services for the base of the socioeconomic pyramid (BoP)

BoP: 4.0 billion of worlds 6.4 billion people

Microfinance: An Industry 4 Decades in the Making

1970s: First microfinance loans & Experimentation

1980 1990: Leading NGOs Break Even

1990 2000: Regulated MFIs: Tapping into Capital Markets

Why does Microfinance Matter?

Majority of Worlds Income is Earned in the Informal Sector

INFORMAL SECTOR Income of >70% of Economically Active Population of the World

Financing the Informal Sector

INFORMAL SECTOR = Income of >70% of Economically Active Population of the World

LAST LINK DISTRIBUTION

Microfinance: A Response to Traditional Sources of Funds

INFORMAL SECTOR = Income of >70% of EconomicalLy Active Population of the World

LAST LINK DISTRIBUTION

Economic Fate & Citizen Empowerment are Linked

INFORMAL SECTOR = Income of >70% of EconomicalLy Active Population of the World

Higher Income: Access to the Key Drivers of Better Futures

Microfinance Today: Part of the Financial Sector

2000 2010: IPOs - Publicly-traded shares in stock exchanges

No. Clients (000) 146 581 1,900

Loan s ($MM) $ 435 $1,306 $ 750

$1 billion overhang in funds raised to invest in microfinance

Michael Chu, Harvard Business School

Yet Microfinance Penetration is Just Beginning

Families Reached: Approx. 150 MM Active Clients - Credit

Loan portfolio: Approx. $45 billion to $60 billion

Just the basic product: Working Capital loans

Savings lagging Other financial products & services just beginning

Just the easiest to reach clients

Remote rural areas lagging

Total Market Basic WK Loans : Approx. 545 MM families - $272 billion

Basic WK Loan Penetration:

No. of Active Clients: < 28% Portfolio Volume: < 20%

Michael Chu, Harvard Business School

Multitude of MFIs, but Industry defined by Leaders

Market: Base of the Pyramid

Large: significant volume

Michael Chu, Harvard Business School

Today: Rapid Change Continues Unabated

The Promise of the Future

Competition & Technology: Together, finally solving the M/Fs paradox:

Going from todays 150 MM clients to tomorrows 500 MM:

Tomorrow: Models that disrupt todays microfinance establishment

Just as todays models disrupted yesterdays traditional banking

Holy grail: from high touch to no touch

Radical reduction in costs Quantum leap in pricing and coverage

The Threat of the Future

Todays high visibility of microfinance: High Numbers Reached

High numbers are essentially the result of commercial microfinance

Regulatory oversight of Microfinance: Essential

How serious is the threat?

Compartamos Banco (Mexico) SKS (India)

Michael Chu, Harvard Business School

Microfinance: The case of Compartamos Banco

1990: Initiative of a social NGO

Initial operations in Chiapas & Oaxaca (rural)

2000: SOFOL Compartamos

2002: First bond issue 2006: Bank: full-banking license

Microcredit loans to rural population 93% of loans