Microfinance Needs Profits, Best Practices, and Technology

More tragic than the world’s “financial apartheid” is the development community’s attitude about cutting the number of people living on less than $1 a day to 500 million by 2015—the goal of United Nations’s Millennium Development, said Vikram Akula, PhD, ’04 (economics), CEO and founder of SKS Microfinance. Even more tragic is the microfinance industry’s target in the Microcredit Summit Campaign 2006 to reach 275 million poor households in the next 10 years, Akula said.

“After 30 or 40 years, the microfinance world is saying ‘We’re comfortable with 30 to 40 percent of the poor having access to finance,’” he said. “Clearly, we couldn’t imagine this in any other industry. If people in the IT industry said it, write off the industry as underperforming. In microfinance, we not only accept it, we celebrate it, and that is the single biggest flaw of microfinance,” Akula said. “You get what you strive for. If we strive to eradicate poverty through microfinance, we will do it.”

Akula was among keynote speakers at the Chicago Microfinance Conference May 25 at Gleacher Center. The event, organized by the student-led Emerging Markets Group, also featured a keynote by Elizabeth Littlefield, CEO of the Consultative Group to Assist the Poor (CGAP), and a panel discussion on technology and distribution innovations for scalability.

As a result of traditional microfinance’s approach, almost 90 percent of the world’s MFIs serve fewer than 10,000 clients each, Akula said. Of those 10,000 MFIs, CGAP reports only 150 are financially sustainable, he said. “This underperformance leads to a huge gap between what is needed by the world’s poor and what’s actually delivered,” Akula said. For example, in India the projected need for credit is $58 billion, but just $5 billion has been dispersed this year, he said.

Working at a “mom-and-pop MFI” in India before launching SKS, Akula encountered constraints to scaling in capital, capacity, and cost. “This hit home for me when I worked as a loan officer in a drought-prone region of South India,” he said. “Women in neighboring villages wanted our service, but management said we didn’t have the funds or the systems and couldn’t really afford the costs. So I’d go back and tell these women that. One woman in particular said something I will never forget. She said, ‘Am I not poor, too? Do I not deserve an opportunity to get my family out of poverty?’”

For Akula, that was the crux of microfinance. “So I left my NGO, came here to the University of Chicago, got my PhD, and thought exactly about this question,” he said. “How do you design microfinance in a way that you never have to say no to any poor person who’s simply asking for an opportunity?”

Akula’s development thesis, which is used by many members of a new generation of MFIs, emphasizes a profit-oriented model, draws best practices from the business world to scale more radically, and uses technology to lower the cost of streamlining processes, he said. This new generation eschews the notion that microfinance is a social business with no profit and no loss, Akula said.

“Our view is that the only place you’re going to get $58 billion in credit for the Indian market and an estimated $300 billion for the global market is in the commercial capital markets,” he said. “And the only way you’re going to get commercial capital is not by being marginally profitable, but by being ridiculously profitable.”

SKS started as a NGO, converted to a finance company, and last year declared a 24 percent return on equity, Akula said. “Clearly in the beginning we had social investors come in, but today we have Sequoia Capital, arguably the world’s largest or premiere venture fund, investing in SKS,” he said. “They don’t have an interest in the poverty eradication piece of this. They’re interested in making money. We see that as a success, because the Sequoias are exactly the type of institutions that have $300 billion to deploy. If we give them confidence to put their money in the hands of poor women, then we’ve solved the capital problem.”

Critics argue that SKS and its ilk are exploiting the poor. “The answer is that, in fact, you can charge an interest rate that continues to be the lowest cost financing available to the poor and still deliver to Sequoia the kind of return that they want,” Akula said. “Moreover, those rates will drop as more entities join the market. So you can run a highly profit-oriented model and yet do right by the poor.” After cost of capital, the borrowers’ return on their investment ranges from 29 to 236 percent, he said.

Akula argued that public money and social investment should be directed to the underserved and ultra-poor, or those earning less than $1 a day. An audience member suggested Akula is reserving the “sweet spot” in the market—those earning $1 to $2 a day—for the private sector, leaving the “heavy lifting” for donor agencies, and assuring the “best and the brightest,” including the best capital, does not reach the ultra-poor.

“As somebody who’s come out of the NGO, the ‘heavy lifting’ world, I’m taken a little bit aback by saying that the best and the brightest go only to the private sector,” Akula said. “I landed in the private sector by default because I thought it was a good strategy for poverty eradication. I think the heavy lifting also attracts the best and the brightest. All I’m saying is that if you are going to spend donor funds, it shouldn’t go into where the private sector can work. Donated dollars and public support should go exactly where the heavy lifting is.”

-Phil Rockrohr