It was merely a coincidence that the year after C K Prahalad's bestseller, The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits (2004), that Vikram Akula returned to SKS Microfinance, leaving a consultancy job at McKinsey & Company in Chicago that he took a year earlier.
Akula, a Fulbright Scholar researching poverty and a student of arts, had founded SKS Microfinance as a non-profit venture in late 1997 with funding close to $52,000 raised from 357 people. He converted it into a for-profit company in 2005 during his second stint. Success came rather swiftly. In 2006, Akula was named by Time magazine as one of the world's 100 most influential people.
In less than a decade, SKS emerged as the largest micro-finance institution (MFI) in the country. Profits after tax (PAT) increased from Rs 2 crore in FY07 to Rs 80 crore in FY09, and Rs 174 crore in FY10. Little wonder, then, that the company's recent initial public offering (IPO) attracted high-profile investors like billionaire George Soros, and was oversubscribed 13.69 times, even with the price fixed at the highest band of Rs 985 a share.
Akula may be much celebrated, but he is not alone. There are dozens of MFI success stories, all of whom have surfaced over the last five-seven years, with a common mandate to "eradicate poverty", profitably. With a turnaround time for MFIs at one or two years, competition among the top few MFIs is intensifying to attract equity investments. Interestingly, with barely 15 per cent of rural households currently MFI borrowers, there is sufficient leeway for growth.
The country's second-largest MFI, Spandana Sphoorty Financial, which will decide on whether to go for an IPO in the next month, is not far behind SKS. In fact, as an NGO, both SKS and Spandana started in 1998 in Andhra Pradesh. As on July 31, Spandana had loan outstandings of Rs 4,205 crore, against SKS's Rs 4,321 crore as in March. Moreover, Spandana is the most profitable MFI at Rs 203 crore the last financial year.
Along the lines of SKS, Spandana was started by NGO worker Padmaja Reddy at Chilakalurpet in Guntur District of Andhra Pradesh. She was working on local development projects funded predominantly by grants, when a woman rag-picker inspired her to strike out on her own. In the first two years (1998-2000), Spandana crossed the Rs 1-crore disbursement mark with around 2,000 clients.
In 2007, JM Financial India Fund and Lok Capital invested Rs 50 crore in Spandana. Another PE firm, Valiant Capital, took an 11.50 per cent stake in the MFI for around Rs 100 crore the following year. A low operating expense ratio close to 6 per cent, against an industry average of 10 per cent has been the driving force behind Spandana's high profitability. For example, Spandan works with five-member borrower groups, not the typical 10-member group.
The oldest among the lot, Share MFI, started by Udaia Kumar in Andhra Pradesh, had its genesis in an action research programme in 1989, becoming a for-profit entity in 2000. Simultaneously, Kumar also promoted another MFI, Asmitha Microfin, in 2002, which is now run by his wife Vidya Sravanthi.
An IPO is next on the agenda for Share. The present PE investor, Legatum, has a 62 per cent stake, and social rural venture capital firm Aavishkaar has 5 per cent. The two invested Rs 100 crore in Share in 2007.
Last year, Asmitha closed its second round of equity infusion with BlueOrchard Private Equity Fund pumping in Rs 50 crore. A plan to merge Share and Asmitha is also under consideration. This would create the second-largest MFI in the country. "We are thinking of merging Share and Asmitha, and the sector will consolidate. But, no decision has been taken so far," said Kumar.
With loan outstandings of Rs 2,234 crore, Share currently the third-largest MFI posted a profit after tax of Rs 108.72 crore for the last financial year ended March 31. Asmitha is the fifth-largest MFI, with loan outstandings of close to Rs 1,800 crore.
Bandhan, an MFI based in Kolkata that started operations in 2004, is also looking for a Rs 100-crore equity investment this year. It is the fourth-largest MFI, with loan outstandings of around Rs 1,700 crore, and profits of Rs 70 crore last year. Last year, Sidbi invested Rs 50 crore in Bandhan to pick up 10 per cent stake. "We have not decided about an IPO, but one never knows the future course of action," said Chandra Shekhar Ghosh, founder and CEO of Bandhan.
In general, an IPO is a pragmatic exit route for PE firms and, thus, a compelling factor for most MFIs to go public. The investment tenure of PE firms ranges between three and five years. For instance, in the case of SKS, more than half the issue comprised secondary sale of shares. Of the 16,791,579 share float, fresh issuances are 7,475,323, while PE firms Sequoia Capital and Mauritius Unitas Corporation, apart from SKS Capital and five other trusts, have offered 9,346,256 shares. Akula also sold part of his stake to hedge fund Tree Line Asia prior to the IPO.
It is widely perceived that the high profitability of MFIs stems from high interest rates, with margins as high as 10 per cent in some cases. Even, Reserve Bank of India (RBI) has expressed concerns over the high rates of interest charged by MFIs.
"Cost remains an issue. Interest rate charges at 24-30 per cent seem too high. Compared to the informal sector, perhaps the rates are lower, but there are questions about whether these rates are affordable. Ideally, the interest rate charged should not be out of alignment with the cost of funds, transaction costs, risk costs and a certain margin. And in any case, there is a need for transparency in its determination and fairness in application," RBI Governor D Subbarao had said in Kolkata last December.
Recently, a senior RBI official publicly denounced even the most respected MFI in the world, Grameen Bank, for charging exorbitant rates of interest. "It is time that the MFIs reduce their interest rates, particularly if the MFI movement is to continue," U C Sarangi, chairman, Nabard, had also said last month.
MFIs, on the other hand, defend the rates due to their high operating expenses, and serving a section of the population that is otherwise financially excluded. In the wake of the widespread criticism, recently a few MFIs reduced their rates of interest. Bandhan slashed lending rates by nearly five percentage points to 19.1 per cent, from 24 per cent, on a reducing balance.
"A loan invested in vegetable or fruit vending gives a return of over 100 per cent a day. An interest rate of 24 per cent per annum is nothing against these returns. Unfortunately, people do not understand the simple economics of a poor household. Nevertheless, I support an interest rate cap. This will sanitise the industry and make players efficient," said Reddy.
But with the economics of poor households working in favour of lenders as of now, for MFIs it is profits as long as it lasts.
