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The Indian Debate Over Profit From Microfinancing ContinuesFew companies or industries ever manage to show a strong tie-in betweenmaking profits and social responsibility. Most times, the former and the latter arediametrically opposed to each other, where one is about earning and the otherabout giving away. Microfinace is one such sector that faces this questionincreasingly.

Microfinance is primarily a mission to provide funds to minor borrowersinterested in setting up small businesses. The concept was pioneered byEconomics Nobel Prize winner Muhammad Yunus in Bangladesh, where smallloans were given out to basket weavers for them to use in their business. Inindia, SKS Microfinance is focused on this particular segment, and recently wentIPO successfully, and has been the subject of criticism for the same.

According to the Nobel Laureate, microfinancing is about social commitment.When you launch an IPO, you are telling investors that there is an oppportunityto profit from lending to the poor, and it can take on an adverse image. The

credit when given for profit will only wind up going to the rich, not to the poor forwhom it is meant, since the company has to keep an eye on the bottomline.

SKS was set up as being a social enterprise, a company that did well by doinggood unto others. However, the IPO has left many of its believers disenchanted,with board members Gurcharan Das, Anu Aga and Narayan Ramchandran ofMorgan Stanley quitting just days before the IPO prospectus was released. Thecompany founder Vikram Akula is quick to point out that the IPO gave SKSaccess to more funds which could be used for greater good. Otherwise, theimpact of SKS would have been limited, he claims.

Akula has the right kind of credentials to make SKs a success. A social worker fortwo decades, he set up SKS as a non-profit in 1997, joined Mckinsey and Co. in2004 as a consultant and returned to SKS in 2005, when he changed thecompany to a for-profit. Akula estimates that poor households in India need closeto US$50 billion in credit, only 10% to 15% of which has been met by all MFIscombined because of lack of access to capital.

The recent termination of the companys CEO created adverse publicity for SKS,but Akula is lining up to come back as executive chairman, and this could be thecause of the power struggle within the company. Since money-grubbing is seenas socially unacceptable, a fight in SKS over money and power would be theworst possible scenario for the company to present to its investors and the public

alike.

Taking a profit-oriented approach in a social cause is always risky, though manyhave been talking of sustainable social development. The recent happenings atSKS only serve to show how far we have yet to go.

Capitalism vs. Altruism: SKS Rekindles the Microfinance Debate

Published: October 07, 2010 in India Knowledge@Wharton

The marriage of capitalism and altruism is never verycomfortable. One is about making money. The other, thoughoften indirectly, is about giving money. Early in October, SKS

Microfinance -- a company that makes money lending to thepoor -- sacked its CEO Suresh Gurumani. In a terse note, SKS informed the

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Bombay Stock Exchange (BSE) that the company "had withdrawn all powers andauthorities granted to [Gurumani] or otherwise enjoyed by him." Said economicdaily Business Standardin its lead-story headline: "SKS Microfin sacks CEO;shares tank." Reported Moneycontrol.com, a web portal belonging to TV channelCNBC TV18: "Sacked SKS Microfin CEO may sue company."

For SKS, this is a second round of controversy. It is the first Indian company inthe microfinance sector to go in for an initial public offer (IPO). It is among thefirst half-dozen anywhere in the world to list. (Banco Compartamos of Mexicowent public in 2007 and drew considerable criticism.) SKS had a very successfulIPO in August, being oversubscribed more than 13 times. Ironically around thattime, several big issuers -- including public sector majors -- were waiting for themarkets to improve. SKS raised US$358 million. It got around US$22 per share(Rs. 985 at US$1 = Rs. 44.75), the upper end of the price band. It jumped morethan 16% on listing and, today, even after plunging when the CEO was fired, issome 30% above the issue price.

According to Nobel-prize-winning economist Muhammad Yunus, who pioneeredthe microfinance industry in the 1980s by giving small loans to basket weaversin Bangladesh, "Microfinance is mission-driven banking. When you float an IPOyou are telling your investors there is a good opportunity to make money offpoor people. The message is wrong, the direction is wrong.... Staunch believersof market forces keep saying competition will bring business to people who arenow unreached. Over centuries, this has not happened. Competition neverbrought credit to the poor; it only took it to richer people. That is the route theIPO will take them."

Taking the For-profit Route

Yunus, who spoke to India Knowledge@Wharton from Bangladesh, pioneered the"social business" model where there is no profit involved for the investor orpromoter. SKS and its ilk are taking a totally different route. Wrote The New YorkTimes at the height of the SKS IPO controversy: "SKS was set up as whatphilanthropists call a "social enterprise" -- a business based on the concept ofdoing well by doing good... there is no question that the company's 41-year-oldIndian-American founder Vikram Akula and investors who include prominentSilicon Valley venture capitalists will do very well indeed from the IPO. Akula hasalready privately sold shares worth almost US$13 million, and he still holds stockoptions potentially worth US$55 million. The question is whether the social goodwill be as amply rewarded." Headlined TheWall Street Journal: "SKS

Microfinance's IPO Plans Pit Capitalism vs. Altruism."

There were some disillusioned casualties. A Seattle-based nonprofit, which stoodto make a handsome amount by selling its stake in SKS, decided to close shop."You are encouraging profit maximization while nonprofits are closing down,"

Yunus pointed out then. "That shows the real result of this IPO."

In India, there have been departures, too. M.S. Sriram, Lalita D. Gupte ChairProfessor in Microfinance at the Indian Institute of Management Ahmedabad(IIMA), writes in a paper titled "Commercialization of Microfinance in India: ADiscussion on the Emperor's Apparel": "There were three high profile persons --

Gurcharan Das, the author ofThe Difficulty of Being Good, Anu Aga of Thermaxand Narayan Ramachandran of Morgan Stanley -- on board [the SKS group] till

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days before the [IPO] prospectus was filed. Their sudden resignation in March inthe run up to the filing of the prospectus raises some questions."

SKS founder and chairperson Akula, however, has no doubts that his way is best."The path of the capital markets is the path that will lead to the greatest social

impact," he says. "Otherwise, you are limiting your reach and, in effect, notproviding financial services to all those people that you could." He admits that itdid take some time to make the regulators comfortable with the idea of amicrofinance institutions (MFI) going public, but that was only because it was anew concept. (To watch a video interview with Akula conducted during the 2008Wharton India Economic Forum, see: "SKS Microfinance's Vikram Akula: 'MobileBanking Could Be the Future of Microfinance.')

The Right Credentials

Akula has all the right credentials. He began working in rural India two decadesago as a community organizer of women's self-help groups for a nonprofit. He

set up SKS Microfinance as a nonprofit in 1997, went to McKinsey & Co inChicago as a consultant in 2004, and came back to SKS in 2005. He returned aconvert; in 2005, he made SKS a for-profit. In 2006, Akula was named by Timemagazine as one of world's 100 most influential people. Also in 2006, he wasgiven the Social Entrepreneur of the Year award at the World Economic Forummeet in Delhi. He is currently writing a book appositely titledA Fistful of Rice: MyUnexpected Quest to End Poverty through Profitability.

At SKS, Akula has delivered on the profitability front. The latest quarter endedJune 30, 2010, saw profit after tax increase 265% to US$15 million compared tothe corresponding period the previous year. Gross income increased by 82% to

US$70.82 million. As of March 31, 2010 (the company's year-end), SKS had totaldisbursements of more than US$3 billion and 6.8 million women borrowers. Thisgives it almost three times the growth rate of Muhammad Yunus' Grameen Bankin Bangladesh.

Akula estimates that poor households in India need close to US$50 billion incredit, only 10% to15% of which has been met by all MFIs combined because oflack of access to capital. "The best way to raise large capital is from commercialcapital markets and the best way to tap commercial capital markets is to bestructured as a profit-oriented institution and do an IPO," says Akula. "It isprecisely where that US$50 billion will come from; it is the only place it can comefrom. That is why we did this IPO."

Akula is not interacting with the media after the departure of Gurumani. An SKSspokesperson, referring to Gurumani's comment that he could sue, says that thedeposed CEO can go the courts if he likes. "We have done what we have to do,let him do what he has to," he says. "I cannot comment on his behalf. We havenot received any [legal] notice so far."

Battle for Control

The battle in SKS seems to be about control and money. The company hasclarified that there were no issues of financial irregularity in Gurumani's

departure. But the power struggle, as the media has dubbed it, was evident evenearlier.

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Akula has a very high-profile. Observers speculate that he did not expect theadverse reaction and the global debate over the IPO. The Indian media coveragewas actually muted; articles in the Western media raised problems. People withinSKS say that Akula allowed Gurumani to take the lead in the IPO as he preferredto stay away from the acrimony. Once the issue was a done deal, however, andthe heat was off, he wanted to get back to the helm. The shares were listed onAugust 16. At a board meeting held in early September, SKS appointed Akula asexecutive chairman from November 1. (He is currently non-executive.) M.R. Rao,chief operating officer, was elevated to deputy CEO with immediate effect. Thewriting on the wall for Gurumani was getting clearer by the day.

The only issue, say company insiders, was about the terms of disengagement.Gurumani had already cashed out most of his stock options. The board offeredhim a handsome amount -- upwards of US$1 million -- to resign gracefully. Hewanted more. "He was originally given 900,000 shares when he came on," says acompany spokesperson. "He sold 225,000 shares prior to the IPO. Another675,000 would have vested in him over a period of four years. After the

termination, he doesn't get a single share. He has no right to his stock optionsright now. He can't sell anything."

Not a Moral Issue

The issue in this and the larger debate about nonprofits turning for-profit is oneof context, experts note. In a purely capitalist society, this would have been theway to go; Akula would have been a folk hero. In India, which still has a socialistethos, there is distaste for money grubbing -- and what some might evenperceive as greed.

"This is not about morality," says Ramesh Ramanathan, promoter-director ofJanalakshmi, a social enterprise. "It's not about good and bad. It's about thenature of markets. Markets are a double-edged sword. The power of the marketfor innovation, for raising money, for hiring good people, for bringing value tocustomers... all that positive also comes with baggage. That baggage is greed."

"When an MFI becomes for-profit, the danger does exist that it might lose itsmoral and ethical compass," says Sriram of IIMA. "Everybody succumbs to thelure of the market." Sriram feels that Gurumani's departure has nothing to dowith this dilemma, although the squabble over the golden handshake is anothermatter.

Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based IndianSchool of Business (ISB), agrees. "It seems to be the consequence of an internaldisagreement about the management of the organization between the CEO andthe board and perhaps between the CEO and the chairman," he says. "Thesethings are quite common in organizations, only they are handled a bit carefullyso that CEO terminations are relatively rarer. Given that Akula, the founder, is inthe driver's seat, the exit should not hurt SKS too much."

SKS has "sought to take a profit-oriented approach to microfinance," hecontinues. "There is absolutely nothing wrong with that. This is an ongoingdebate in the microfinance area. Everyone admits that without the profit motive,

it is difficult to have organizations that would engage in the activity in a

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sustained and efficient manner. On the other hand, a total fixation on the bottomline can easily lead to mission drift."

Chakrabarti quotes a recent paper published in theJournal of EconomicPerspectives titled "Microfinance Meets the Market": "Globally, the social

development model accounts for about 90% of microfinance organizations but10% of profit-oriented providers are very large and account for over half of theindustry assets. The nonprofits lend more to the bottom of the pyramid while thefor-profits tend to focus on a slightly higher tier. Also nonprofits are more likelyto go for group-lending while for-profits go largely for individual-lending. So, inconclusion, for-profits and nonprofits have somewhat different profiles in themicrofinance industry, but both have important roles to play."

Laws Need Change

Yunus is not so sure. He believes that laws should be changed if they preventlending to the poor. "If the government is poor-friendly, it should make laws to

create banks for the poor and the poorest," he says. Deval Sanghavi, presidentand co-founder of Dasra, a venture philanthropy fund, feels that non-bankingfinance companies (NBFCs) should be allowed to raise external commercialcapital. "If the government were truly committed to social change, it shouldenable 1% loans to come into the country and then lend at 3% to 5%," Sanghavisays. Rahul Saikia, vice-president, investment banking at Enam Securities,believes the rule that requires banks to have 40% of their portfolio in the"priority sector" should be amended to withdraw priority sector status from MFIs."That's what MFIs are surviving on today. If you remove that, only the qualityMFIs will survive," he says.

Such changes would enable MFIs to access lower-cost funds. But it wouldn't be asubstitute for the capital markets. Says Sumir Chadha, managing director ofSequoia Capital India, SKS' largest investor: "The not-for-profit world in India isfilled with well-meaning people, but the challenge is that no one is going to giveyou enough funds to scale up. Grants just don't scale to that level." Additionally"from a banking standpoint, there is no way you can get debt since it's apercentage of how much equity you have," adds Ash Lilani, president, Asiamarket, SVB Capital, another SKS investor.

But Yunus thinks there is enough money in the villages. "Grameen Bank doesn'thave a problem with money. It takes deposits and lends money. The solution isnot in going to IPO; the solution is in treating microfinance as banking. That

would be the right direction rather than rushing to the big-money people,offering them an opportunity to make money for themselves out of poor people."

What troubles Sriram of IIMA is the idea that one should not make money whiletapping the bottom of the pyramid. "Very much the way we don't get upset whensoaps are sold to the poor, we should not get upset that people are makingmoney from microfinance," he says. He finds dissonance, however, when thisobjective is juxtaposed with the lofty mission of eliminating poverty. "There islittle evidence to show that microfinance eliminates poverty," he says, "If thathad been the case, Bangladesh should have declared itself poverty-free."

Janalakshmi's Ramanathan cites the case of SKS itself. "Vikram Akula constantly

communicated a message that it's a social business. But when push came toshove, the actions were all of a commercial enterprise," he says. Adds Dasra's

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Sanghavi: "The IPO is not unethical or illegal, it's just disappointing." Yunus, asterner critic, says that once MFIs are in the business to make money, no amountis ever enough. "Interest continues to go up because the market will force [MFIs]to go in that direction and you end up becoming a bigger and bigger loan shark."(Today MFIs charge 28%, higher than the banks but lower than the villagemoneylender's 50% plus.)

The Goats and the Sharks

Everyone at SKS has made money, though some more than the others. WhenAnjamma took her first loan from SKS in 1998, it was for US$33 to buy a goat,says the company's 2009-2010 annual report. Today, several other goats andloans later, she owns a buffalo and a plot of land worth $889.

"First microfinance IPO makes millionaires out of employees," reports BusinessStandard. "K. Nirmala, 31, will prepay her home loan shortly, courtesy the stockshe held in SKS Microfinance -- her employer for 13 years.... Nirmala is not alone.

Five days after the company was listed, many of her colleagues are findingthemselves in the league of millionaires."

Gurumani, who had exercised his option to purchase 225,000 shares on March23, 2010, has made a profit of US$1.69 million by selling his shares under a prioragreement, says the paper by IIMA's Sriram.

At SKS Microfinance, money is going places.