Michael Chu Fsf2011

8/4/2019 Michael Chu Fsf2011

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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School Copyright President & Fellows of Harvard College.

Michael ChuHarvard Business School

MICROFINANCE: INCLUSION & SUSTAINABLE BUSINESSFinancieros sin Fronteras IE Business School, 22 February 2011

Microfinance: Today and Tomorrow


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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School

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

1Billion

1.4Billion

1.2 Billion

1.6 Billion

1.2 Billion

Base of the

Pyramid

Microfinance

Sweet Spot:

C, D, E+

Approx. 3.25 Billion

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Why does Microfinance Matter?

POVERTYLACK

OFINCOME

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Majority of Worlds Income is Earned in the Informal Sector

POVERTY

INFORMAL SECTOR Income of

>70% of EconomicallyActive Population of the

World(OIT, 2002)

INCOME

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Financing the Informal Sector

POVERTY

INFORMAL SECTOR= Income of

>70% of EconomicallyActive Population of the

World(OIT, 2002)

INCOME$

MONEYLENDER

LAST LINKDISTRIBUTION

5


7/44Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School

Microfinance: A Response to Traditional Sources of Funds

POVERTY


>70% of EconomicalLyActive Population of the

World(OIT, 2002)

MICROFINANCE

INCOME

STRETCHESINCOME

EXPANDSINCOME

INCREASESINCOME

MONEYLENDER

LAST LINKDISTRIBUTION

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Economic Fate & Citizen Empowerment are Linked

POVERTY


>70% of EconomicalLyActive Population of the

World(OIT, 2002)

MICROFINANCE

INCOME

BASIS FORCIVIC

RIGHTS

STRETCHESINCOME

EXPANDSINCOME

INCREASESINCOME

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POVERTY

SIGNIFICANTIMPACT

EDUCATION

HEALTHCARE

HOUSING

BASICSERVICES

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Higher Income: Access to the Key Drivers of Better Futures

ADDITIONALINCOME

MICROFINANCE

STRETCHES

INCOME

EXPANDSINCOME

INCREASESINCOME



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:

3. Mainstream:

$1 billion overhang in funds raised to invest in microfinance

Institution No. Clients (000) Loan s ($MM)

BancoSol 146 $ 435

Mibanco 581 $1,306

Compartamos 1,900 $ 750

Grameen 8,300 $ 956

SKS 7,700 $ 980

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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%

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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 MFIsRegulated Efficient Self-Sustaining High Returns

Most profitable Most Solvent

High Growth

Capital Markets

Financial

Investors

Corporations

Public

National Banking/

Financial Authorities

Market: Base of the PyramidLarge: significant volume Growth segment Sustainable asset quality

Financial Instruments

Deposits

FinancialServices

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Multitude of MFIs, but Industry defined by Leaders



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

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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

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The Threat of the Future

1. Todays high visibility of microfinance: High Numbers Reached

1st & 2ndDecades: 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)

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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

4. 2006: Bank: full-banking license

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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 weekspayments and deposits

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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

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SKS

1. 1997: NGO established by Vikram Akula

2. 2005: Converted into a for-profit

$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

With thanks to Prof. Shawn Cole, Harvard Business School

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Year Assets (USD) Borrowers

1998 45,177 19

1999 103,338 191

2000 116,045 1,068

2001 508,567 5,080

2002 1,387,165 11,127

2003 4,089,187 24,799

2004 9,130,883 73,635

2005 26,811,799 172,970

2006 78,797,574 513,1082007 336,831,099 1,629,474

2008 596,162,206 3,520,826

2009 897,871,054 5,795,028

2010 980,000,000 6,780,000

SKS Growth


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SKS Performance

INDICATORS SKS FY2010

Portfolio Growth FY 08-FY 09 54%

Portfolio CAGR Last 5 Years 166%Portfolio At Risk 30 Days 0.40%

Portfolio Yield 25.7%

Debt to Equity 3.2

ROA 5.0%

ROE 22.0%


Source: CGAP, based on MIX & SKS

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SKS IPO

1. July 28 to August 2, 2010: Issue shares for $350 MM

Primary (New shares): $155 MM Secondary (Existing Shareholders): $195 MM

2. Anchor Investors:

JP Morgan Morgan Stanley ICICI Prudential Quantum Fund

3. Underwriters: Citigroup, Credit Suisse, Kotak Mahindra

4. Market Capitalization: $1.5 billion


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Andhra Pradesh (AP) Crisis: The Setting

1. The home state of the leading Indian MFIs

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

Institution Clients Portfolio($ MM)

GlobalRank

(By Clients)

SKS 5,795,028 $960.8 4

Spandana 3,662,846 $787.3 6

SHARE 2,357,456 $490.9 7

BASIX 1,114,468 $223.2 14

Source: Prof. Shawn Cole, Harvard Business School

2009 Data

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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

3. Fall: Press stories: Suicides attributed to microfinance debt

4. October 15: Andhra Pradesh State Government Microfinance Ordinance

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 practiceso Later revised to public places

Source: Prof. Shawn Cole, Harvard Business School

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The Debate

Critics Allegations

1. MFIs: Usurious rates Vs Govt SHG Program: 3%

2. MFIs poaching SHG clients SHG: tiny amounts Slow processing

3. MFIs encourage multiple loans

4. MFIs: Coercive Collection

5. MFIs: Focus on growth

MFI Response

1. Crisis: Invention of local media Owned by opposition parties Local political issues Ordinance: result of political crisis

2. No suicides actually linked to M/F Prior allegations of suicides:

Bank loans, droughts, floods, high-yield cotton, and microfinance

3. No systematic rise of M/F suicides As M/F has spread

24Source: Prof. Shawn Cole, Harvard Business School


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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)

5. Response of Indian Central Bank (Reserve Bank of India-RBI):

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)

25Source: Prof. Shawn Cole, Harvard Business School


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Malegam Comm Report Jan 2011 Main Recommendations

1. Microfinance: Separate category with its own regulations

2. Best Practices:

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

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Evaluating the Malegam Recommendations

Positive:

1. Thoughtful, analytical and well-researched: Some key best practices

2. Interest Rate Caps: Set at levels that allow better MFIs to survive

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

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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

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Direct Trade-off:High Commercial Returns & High Social Impact

1. High commercial returns are made possible by high prices

2. Key to social value is price; the higher the price, the lower the social value

C

O

M

ME

R

C

I

A

L

R

E

TU

R

N

S

High

Low HighSOCIAL VALUE

Rationale:

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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):

Accordingly, ROE can increase while price falls so long as it is more than offset byAsset 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

Net Income Revenue Total Assets Net IncomeROE = --------------- X ----------------- X ------------------ = ----------------

Revenue Total Assets Equity Equity

(ROS) (Asset Turn) (Leverage) (ROE)

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Definition of Success for Social Programs: BEST

1. Best: The most effectiveoption

2. Economical: At the lowestprice for the end-user

3. Solidarity: For allthose that need it

4. Today: As urgentlyas possible

This applies to all social interventions, and M/F is no exception.

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SOCIALLYSUSTAINABLE

SOCIETYMICRO

FINANCE

EDUCATION

HEALTHCARE

HOUSING

BASICSERVICES

ACCESSBY ALL

TO

Achieving the full potential of society

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What to do is, by andlarge, known and

simple

The challenge is tomake it available tothe majority of the

world

BEST:TRANSFORM THE

LIFE CHANCESOF THE PEOPLE


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MICROFINANCE

EDUCATION

HEALTHCARE

HOUSING

BASICSERVICES

To achieve BEST: S2E2

SCALE

SUSTAINABILITY

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ACCESSBY ALL

TO

TRANSFORM THELIFE CHANCES

OF THE PEOPLE

SOCIALLYSUSTAINABLE

SOCIETY


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MICROFINANCE

EDUCATION

HEALTHCARE

HOUSING

BASICSERVICES

To achieve BEST: S2E2

SCALE

SUSTAINABILITY

CONTINUOUSEFFICACY

CONTINUOUSEFFICIENCY

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ACCESSBY ALL

TO

TRANSFORM THELIFE CHANCES

OF THE PEOPLE

SOCIALLYSUSTAINABLE

SOCIETY


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The war against poverty since WWII

The major warriors, fighting at their best

1. NGOs: Give birth to ideas that can

change the world

2. Philanthropy: Nurture those ideas sothey develop

3. Developmental Agencies: Support

those ideas so they can be field-

tested

4. Governments: Take the proven ideas

that are most promising and deploy

them nationally

None of them, individually or

collectively, are structured for scale

or sustainability

National scale & a measure of

permanence, but not structured for

continuous efficacyor continuous

efficiency

cannot provide simultaneously and consistently

what is necessary to win. 35


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MICROFINANCE

EDUCATION

HEALTHCARE

HOUSING

BASICSERVICES

Delivering S2E2: Business

SCALE

SUSTAINABILITY

CONTINUOUSEFFICACY


PRIVATEENTERPRISE

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ACCESSBY ALL

TO

SOCIALLYSUSTAINABLE

SOCIETY


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MICROFINANCE

EDUCATION

HEALTHCARE

HOUSING

BASICSERVICES

But not through one single enterprise but an Industry

SCALE

PERMANENCE

CONTINUOUSEFFICACY


VIAINDUSTRIES

(NOTFIRMS)

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ACCESSBY ALL

TO

SOCIALLYSUSTAINABLE

SOCIETY


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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 tothe customers at the base of the pyramid

This is the social role of an industry

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BancoSol (Bolivia)

0.284

0.240

0.230

0.217

0.221

0.2120.211

0.203

0.198

0.198 0.197

0,18

0,2

0,22

0,24

0,26

0,28

0,3

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

In

terestRate

Year

Average Weighted Interest Rate Loan Portfolio

Source: BancoSol

Interest Rates 2000 - 2010

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Bolivia Microfinance Industry:The Lowest Interest Rates for the BoP in Latin America

Source: Asofin

Dec1998

Dec2010

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An Empirical Observation: High Commercial ReturnsCan be Integral to High Social Impact

1. High commercial returns create industries

2. Industries produce S2E2 to ensure BEST for the Base of the Pyramid

C

O

M

ME

R

C

I

A

L

R

E

TU

R

N

S

High

Low HighSOCIAL VALUE

Rationale:

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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School Copyright President & Fellows of Harvard College.

Michael ChuHarvard Business School

MICROFINANCE: INCLUSION & SUSTAINABLE BUSINESSFinancieros sin Fronteras IE Business School, 22 February 2011

Microfinance: Today and Tomorrow


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A Reflection on Randomized Evaluations in Microfinance

Randomized clinical trials

Origin: Medicine, e.g. penicillin

1. Single solution: vs infection

2. Bulls-eye metrics: evol. Infection

3. Uniform: penicillin = penicillin

4. Generalizable

5. Random sample OK

6. Timeframe appropriate

Microfinance

1. Poverty: multiple interventions

2. Working Cap, PPE, Housing

3. Heterogenous: MIF A MIF B

4. Segmentation

5. Targeted selection: Key

6. 12 to 18 Mos: 2-3 6-mo. loans

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Michael Chu Fsf2011