On Monday, Bharat Financial Inclusion Ltd. and IndusInd Bank Ltd. informed stock exchanges that the two firms are in exclusive talks for a merger. If concluded, the deal will bring to an end the independent history of Bharat Financial, initially christened as SKS Microfinance.
The microfinance company was founded by Vikram Akula in 1997. Akula pushed a for-profit microfinance model in India, arguing that this is the only way to attract talent and investors to lending to the bottom of the pyramid. In August 2010, SKS Microfinance became India’s first listed microfinance company.
But SKS had a bumpy journey ahead.
In late 2010, a crisis broke out in the microfinance sector in Andhra Pradesh, where SKS’ operations were concentrated. The crisis followed an ordinance by the state government which restricted microlending in the state and clamped down on loan recovery practices. Microfinance firms in Andhra Pradesh, including SKS Microfinance, were crippled. The industry settled after regulation of the microfinance industry was taken up the Reserve Bank of India.
The crisis for SKS, however, did not end there. In November 2011, founder Akula was forced out of the company following a high-stakes battle between the management and the board regarding future strategy. After Akula’s exit, the company and its new management tried to de-risk the company’s balance sheet. It also applied for a licence to convert itself into a small finance bank which was later denied.
In an exclusive email interview with BloombergQuint, Akula commented on the initial idea behind the business, its pitfalls and its prospects.
What was the genesis of the Bharat Financial Inclusion Ltd. (BFI) idea when you first conceptualized it?
I founded BFI in December 1997, almost twenty years ago, to build that next-generation microfinance company, and I did so on commercial lines. If the industry was going to provide the crores of rupees of credit needed by the poor, it would have to tap commercial capital markets—and that meant charging interest on loans so that investors could expect market-based returns. For customers, paying an interest rate, even as high as 24 percent was fine, because—as long as they were engaged in income-generating activities—customers earned very high returns on micro-enterprises and had plenty of profit, even after paying a 24 percent interest rate. What was important to them was timely access to finance, not the costs. So setting up BFI as a commercial entity was win-win. Customers did well. Investors did well.
Was it perhaps too early (at that time) to work with a for-profit microfinance model?
It was not too early. In fact, the model had succeeded. Just look at our numbers. In the first decade after we started operations in 1998, BFI had scaled to 35 lakh customers and a disbursement of over Rs 5,000 crore, with a 98 percent repayment rate. There were no incidents of over-lending. The problem was that, seeing the success of BFI in its first decade, many new microfinance institutions (MFIs) entered the market and started cutting key processes, such as training customers.
Keep in mind that, in its first decade, BFI field staff took new customers through a 5-day training process, using highly visual teaching tools (cardboard cut outs, seeds, and coins) to teach illiterate and semi-literate customers about procedures for receiving and effectively utilizing a loan. In doing so, we ensured that groups used their deep local knowledge to only enroll people who had the capacity to run successful micro-enterprises. Groups also thoughtfully reviewed loan applications, approving amounts that were in line with each customer’s capacity and checking to make sure customers used loans for generating income. Unfortunately, many new MFIs did not have an understanding of such critical features, and they took short cuts.
For example, they whittled down training from 5 to 4 days and so on. Eventually, there were pockets of hyper competition, where MFIs eliminated group training completely. This led to enrolling customers who did not have the capacity to invest in micro-enterprises; this eventually led to incidents of over-indebtedness. Unfortunately, to avert poaching of their customers, even established players—including BFI—starting mimicking these bad practices.
This started happening at BFI after I left the CEO role and handed over management to bankers from outside of the microfinance sector. I thought they understood the business, but it turns out they didn’t.
Incidents of over-indebtedness then gave a platform for the political backlash, some of which was maliciously motivated and some of which was based on genuine concern for customers who were in over their heads. My new book, which will be published in June 2018, will provide an insider’s view of those events. It also explains how RBI regulations eventually addressed the issues and allowed the sector to flourish. If not for the boldness of the RBI stepping into that regulatory vacuum, the sector would not have had its resurgence.
BFI has now seen two boom and bust cycles. Does that point to the inherent volatility of the standalone microfinance business?
From a business perspective, the model has proved itself. In fact, there is a 40 year history of success. Muhummad Yunus in Bangladesh and Ela Bhatt in India started group lending in the 1970s. That basic model has weathered economic crisis, political interference, as well as droughts and other natural calamities. It has been able to do so because the group lending model, in essence, relies on the wisdom of poor people and builds on their resilience. Of course, today, the group lending model is losing its relevance in light of the digital economy. And that’s a good thing in terms of financial inclusion.
Today, we are beginning to see elements of credit scoring, which will truly accelerate financial inclusion. For example, you have electronic Aadhaar authentication, credit bureaus with shared data from all lenders, payments banks. We are not quite there yet (especially in rural India), but the elements are in place. It is a very exciting time, with fin-tech for financial inclusion as the final frontier.
Is it possible to remove politics from finance at the bottom of the pyramid? If not, is the business inherently risky for private investors?
Unfortunately, this is one area that concerns me. Even in the recent demonetization effort, we have seen rogue politicians try to take advantage of poor people by telling them not to repay loans. This has affected many players in the sector, and it will ultimately hurt customers who default because they will not get access to future loans. On the other hand, I am hopeful because low-income people are beginning to get more savvy. They are realizing that, regardless of what a politician may tell them, a default gets reported to a credit bureau and such defaults impact their access to finance. In fact, we are seeing customers, who were told by politicians not to repay loans during demonetization, come back and pay their overdues—even in places like Vidarbha.
Basically, as the digital economy emerges, the ability of politicians to interfere will disappear.
You pitched for deposit taking MFIs much before the concept of small finance banks (SFBs) came into being. Now that the SFB concept has been launched, is there any utility to the MFI model?
Yes, I had called for small finance banks more than a decade before the RBI finally announced it in 2014. Though it took a long time to come, I am delighted to see small finance banks (SFB) emerge. The RBI took a bold step by not only creating SFBs but also payments banks. Such a network of differentiated banks have, and will continue to, accelerate financial inclusion. Having said that, there is still a long way to go, and, as such, there is still an important role for NBFC MFIs. For example, by whatever metric you take, financial inclusion is lagging, especially in rural areas. Whether you look at bank branches per capita or loans per capita, it still insufficient. This is especially true if you look at the data from the perspective of low-income communities. So until there are more SFBs—and the SFB sector has a deeper penetration—NBFC-MFIs will continue to have an important role to play. And you see that in the growth rates of NBFC-MFIs.
Whether you look at BFI (my first NBFC) or Vaya FinServ (my new NBFC) or Arth Impact (a start-up fintech venture I have invested in)—all those companies are growing steadily, which shows they continue to fill an important need.