Akula v. Yunus: Commercial Microcredit = Just Profit or Unjust Profiteering?

September 28, 2010

Did you catch the microcredit debate at the Clinton Global Initiative conference last Tuesday? OK, I wasn’t invited to the ex-president’s annual gathering either. But, rather amazingly, I watched the debate live on my Droid while being a soccer dad. You can watch the whole thing at the bottom of this post. It was a good show. It put on one stage the two leading (disagreeing) voices in the hottest controversy in microfinance. And it helped me think through some of the ideas in my Development as Industry Building chapter…but that chapter’s still in draft, so I’d be interested in your thoughts.

Vikram Akula reignited the debate over commercialization and profit in microfinance when he took SKS Microfinance public this summer. SKS is on track to surpass Bangladesh’s Grameen Bank as the world’s largest microcreditor, measured in number of loans outstanding—if it hasn’t already. SKS got big fast by going for-profit in 2005. It raised several rounds of investment from venture capitalists, which allowed it to quickly open thousands of branches implementing its streamlined version of the Grameen’s traditional microcredit system. The SKS initial public offering (IPO) this July allowed those early investors to sell their shares at high multiples of original cost. In fact, even before the IPO, Akula sold enough shares to other investors to become a microcredit millionaire and India’s 9th-largest taxpayer.

As I blogged, Muhammad Yunus, famed founder of the Grameen Bank, has criticized the SKS IPO as he did the Compartamos IPO in 2007. “This is pushing microfinance in the loansharking direction. It’s not mission drift. It’s endangering the whole mission.”

Last Tuesday in New York, NPR’s Adam Davidson moderated a panel that included Akula and Yunus, as well as Mary Ellen Iskendarian, head of Women’s World Banking. I was at once delighted by the subtleties that emerged in the debate, especially in Yunus’s position, and disappointed about an issue left unmentioned. Here, I offer you two quotes (more or less), a pointer on how bank finances work, then three thoughts.

(Some of the transactions affecting ownership of SKS even before the IPO have been controversial too, not to mention complicated—I don’t understand them and don’t approach them here. CGAP has just begun a new stream of work that I suspect will become the definitive analysis of SKS’s journey to the capital market.)

At 14:32 in the video, Akula tells a story about how he concluded that microcredit needed to bring in big investors:

Before starting SKS Microfinance I actually worked for one of these small NGO microfinance institutions, basically as a loan officer. I would give out these small loans and see this tremendous impact that Professor Yunus has written about and shown the world. And what would happen is, women from more remote villages would come to us and say, “Can you start in our village?” And we’d always have to say no, it’s grant-run, so we don’t have funds, and we’d have to turn them away, and they’d walk away disappointed. Now, on one particular day, a very poor woman—emaciated, torn sari, no chappals—she had clearly walked quite a distance to ask me the same question. And again I said, “We don’t have funds. We can’t come into your village.” But unlike the other women who simply walked away disappointed, she looked me in the eye and said something that I’ll never forget. She said, “Am I not poor too? Do I not deserve a chance to get my family out of poverty?” Now, for me this was a jarring question because here I was thinking I’m doing something to help eradicate poverty. But this woman’s question basically put me in my place, basically said: Look, what are you doing if you’re only doing this in a handful of villages and not doing it in the next set of villages? It’s as if you’re sending one child to school and holding one back….How do you design microfinance in a way so that you never have to turn away a poor person who’s simply asking for an opportunity?

Akula’s answer: Go to the capital markets. Bring in big money in exchange for a share of the profits. Grow fast.

At 18:28, Yunus replies with an interesting distinction:

You imply that I am somehow opposed to profit. I am not. Grameen Bank is a for-profit organization. We want to make profit. So we are not [an] NGO. We are a bank. But: ownership is the question. The Grameen Bank is owned by the borrowers. So we make profit. Profit goes back to them. So we protect that part. So what we are opposed to when you say “profit” or “commercialization” is the money of the poor going out to somebody else. And you may say, “Well what’s wrong with taking a small amount of profit?” Then I’ll say, “Is it small? Who defines what is ‘small’? Do you have any rule that will keep it restricted to this percentage? You do not.” It’s an open thing. So anybody who makes profit can do that. So today you may say well we are only making small profit, but tomorrow because of the system you have, you like to maximize your profit. It’s the wrong direction….The moment you say “profit” the sky’s the limit. You saw what happened [in] this financial crisis.

Yunus goes on to emphasize that the Grameen Bank is owned by its clients. And it gets funding not from outside investors, but from the villages it serves, mainly by offering savings accounts:

Grameen Bank is created by the local money. Each branch is created by the local deposits…We live in an ocean of money…We have so much money we don’t know what to do with the money.

To which Akula basically answers: that’s great, but the Indian government won’t let us take savings.

So if I understand right, Yunus is not criticizing commercialized microfinance merely because it makes some people rich. He does not seem to directly begrudge Akula his wealth even though almost every rupee of it came out of the hands of poor Indian women. Rather, Yunus says that outside ownership drives a microcreditor to hurt the customers for the sake of the owners by, say, raising interest rates on loans. I think this is how Yunus links outside ownership to moneylending. A traditional for-profit corporation can be expected to commit usury. Ergo, the customers should be the owners: ownership should be cooperative.

This argument has to be taken seriously: I don’t know anything about Indian corporate law, but I’m guessing that SKS now has a legal duty to maximize shareholder returns. There are thus margins at which client and shareholder interests conflict. And in making this argument, Yunus is harking back to the origins of microcredit perhaps more than he realizes. As I’ve documented in the draft chapter 3, Bangladeshi microcredit traces to German credit cooperatives that began in the 1850s. They were partly inspired by the “first apostle of cooperation in borrowing and finance,” Victor Aimé Huber, who in turn drew inspiration from Robert Owen in England, an originator of the idea that corporations will serve society better when owned by their clients.

So a cooperative bank like Grameen takes two kinds of money from its customers: savings and equity. As for the first, Grameen members have to save some of their borrowings, and many members and non-members voluntarily deposit additional sums with Grameen. (At SKS, loans from big banks take the place of savings, encouraged by a law that requires those banks to lend to “priority sectors.”) Like any bank, Grameen pays interest on these savings according to set formulas and needs to protect the savings at all costs.

As for “equity”: new Grameen members have to buy a 100 taka ($1.44) share in the Bank. And like ordinary shares of stock, the returns to owning these shares are unpredictable. Grameen began paying dividends in 2006 and has paid 30 taka/share the last two years—a good return. On the other hand, if a lot of Grameen loans went bad, the shares could lose all their value. The shares have to take the hit in order to protect the savings. This would be sad, but not catastrophic: that’s what’s great about equity. But—to illustrate the difference between savings and equity—if even more loans went bad, Grameen might become insolvent, unable to return all its savers’ money. That could be catastrophic. That’s what happened to Adam (Davidson)’s Bank when NPR producer Caitlin Kenney defaulted on her dollhouse mortgage. The job of equity is to cushion savings against loan losses.

Understanding that, I’d make three points:

1. The distinction between these two kinds of money is hidden in the way Yunus talks about things. You can’t just finance a bank with savings. The “ocean of money” has been almost all savings: 83.3 billion taka in deposits against just 0.5 billion taka from sales of those 100 taka shares. In fact, Grameen’s total equity cushion, which includes accumulated profits, has not been growing as fast as its loan portfolio, so that the cushion now verges on illegal thinness. It seems that Grameen now needs to sell many more shares to its members. Will they buy? Maybe if purchase is required for new loans or deposits. Grameen and its members have succeeded unconventionally many times before. Otherwise, Grameen will have to scale back its lending…or go to outside investors like SKS.
2. I think it’s easy to overestimate the power of Grameen’s shareholders over Grameen’s management, and to underestimate another check on management: competition. Putting it another way, Grameen’s members may exercise more power when they vote with their patronage (of competing microcreditors) than when they vote their shares to elect board members. Grameen has a strong, autonomous leader, to say the least. I’m not suggesting that Yunus wants to profiteer off the poor, just that Grameen is hardly a persuasive model of how a cooperative structure with millions of members—rather than dozens, as in the original cooperatives—bends management to the will of clients. My reading of Stuart Rutherford’s history is that competition is mainly what has led Grameen and other big Bangladeshi microcreditors to serve clients better, such as by improving savings options.
3. So it seems to me that Grameen and SKS resemble one another more than last week’s debate suggests. Both swim in oceans of money: with its high growth, SKS can easily raise more loans and equity; with its attractive interest rates, Grameen can easily pull in more savings deposits. Both Grameen and SKS face serious competition. Both are growing. Neither is really governed by the poor
   ….which leads me to that “issue left unmentioned.” Here we have two lending operations, growing steadily, egged on by competition, fed by easy money. Have you heard that story before? If I had been in the audience, I would have asked Akula and Yunus: How do you know when growth is development? (Vikram, if you are reading, I think you know this distinction from Herman Daly.) When does multiplication of microcredit constitute a fine contribution to the economic fabric of nations, and when is it a prelude to bubbles? When should we become concerned that microcredit is doing harm by luring many poor into borrowing more than is good for them? I know this question has no easy answer. But it has to be confronted in India and in Bangladesh.

My prior is to favor commercialization and competition in microcredit as maturation of an industry, as true economic development. Most poverty reduction has been caused by similar processes of economic change repeated a thousand times over in various nations and industries, what we call industrialization. But lending is a special business. Here, without proper restraints, commercialization and competition can do a lot of harm. I wish both sides were more persuasive in their implications that their way will work just fine. I’m not predicting doom, just saying that the debate on ownership structure is distracting from something that matters more, and that at least conceptually puts the two sides in the same boat.

What do you think of this? And what do you think about the question I ducked: when is it just to get rich off the poor?

Here’s the whole panel discussion. I’d start at 11:30:

Possibly Related Posts

• Ironies in Yunus Attack on SKS IPO
• Vikram Akula: Early Writings

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1. Jonathan Says:
   September 29th, 2010 at 2:45 am

   Great encounter and thought-provoking framing as usual. I agree with much of what you state but I’m not prepared to say that the debate over ownership is as much of a distraction as you state it is.

   In drawing a contrast between the institutions you state that “a cooperative bank like Grameen takes two kinds of money from its customers: savings and equity.” But my understanding is that Grameen is NOT in any way legally incorporated as a cooperative (which would entail special regulation including limits on ability to raise outside equity). It seems to be a private financial institution not that different from SKS microfinance in the sense that it can and does have outside shareholders to whom it distributes dividends).

   If this is true then what seems to distinguish the two then is (a) SKS cannot mobilize deposits (an imposed legal difference) and (b) that, as Yunus emphasizes, their ownership structures — which once looked quite similar a few years ago — have now diverged (a chosen difference).

   I don’t see anything stopping Grameen the corporate entity from inviting new equity investors or going public. Similarly, while Grameen has financed it’s expansion in large part through savings mobilization, which SKS cannot legally do, I don’t see anything stopping Grameen from also or instead raising credit through bond issues or “loans from big banks,” and if I’m reading its history correctly Grameen has raised credit in these ways in the past.
   The reason that Grameen has not followed this alternate financing strategy is presumably because present management and shareholders feel that dilution of ownership away from clients and social investors (in this case govt investors) would potentially shift the mission in ways that they might fear would be de-stabilizing or destructive of long term objectives (e.g. might shift away focus from the poor, might make donors and social investors less likely to support or come to the rescue, might lead workers now motivated by social concerns to leave and/or become more focused on pecuniary reward which in turn might alter how they interact with clients, etc).

   When SKS Microfinance (the for-profit) was first created it too was primarily a client-owned institution since the ‘SKS trusts’ (the original NGO structured as client-owned non-profits) owned something like 99% of the shares initially since they had sold the existing loan portfolio and operations. Akula as charismatic manager/entrepreneur then chose to bring in new private equity investors that raised lots of money and brought in expertise but also vastly diluted client ownership and, as you pointed out, almost surely shifted the emphasis of the institution more toward the maximization of outside shareholder value. It will be interesting to watch over the next many years how things play out. So long as there is lots of room to grow in India’s underserved MF markets these potential conflicts can be kicked forward, but once the market starts becoming more saturated and competitive it seems more likely that some of those potential conflicts will begin to bite.

   If this were the market for say something like hammers and nails then I’d also agree with your perspective that competition should drive down profits and hence the ‘for profits’ and the ‘non-profit’ providers would end up providing essentially indistinguishable products. But these are markets where donors and social investors and communities and motivated workers are involved, and also markets where it’s not safe to assume that competition will always do its’ textbook job of enhancing efficiency because of the bite of asymmetric information and enforcement problems. Capital and ownership and governance structures are then adapted to circumstances and market segments and they do matter for performance and distribution. I’m inclined to think that the best is to have a mix of types of firms and ownership structures at any given moment, and evolution over time.

   From the work of Henry Hansmann (his book “The Ownership of Enterprise”) we know that ownership structures in early savings, credit and insurance sectors in the USA and other now developed countries mattered powerfully (e.g. policyholder/client owned mutuals have dominated the insurance business for most of its history precisely because, until better regulation capacity was put in place, they were less likely to ex-post opportunistically exploit policyholders than insurance firms owned by outside shareholders, and hence they attracted more clients).

   I agree with your perspective that things such as the level of (well-regulated) competition as well as the rising fortunes of the economy are fundamental factors affecting the long-run success or not of microfinance in any given market. I also agree that both ‘social business’ and ‘private business’ are both perfectly capable of being run very well or very badly. Either type of institution might be destroyed by unregulated competition or too much easy money (though it was the for-profit lenders like Countrywide and not the CDFIs — community development finance institutions — such as Shorebank that peddled the deceptive and often fraudulent loan products that contributed to the subprime mess, even if Shorebank ultimately also was harmed — and the difference in the types of products and practices they employed is in my mind explained fundamentally by their difference in ownership structure).

2. C Says:
   September 29th, 2010 at 7:00 pm

   There is a very real and existent issue with microfinance rates becoming truly extortionate and harming poor people instead of helping them. I imagine there are more instances, but in Mexico for example, there are a number of companies offering microloans at over 100% interest. A not unusual outcome in those situations is that the borrowers end up poorer than before, and the bank comes to repossses anything of value from them. There are legitimate, often very high, costs associated with offering microloans and other banking services to the extremely poor. On Kiva.org for example, where capital is offered to Microfinance institutions at 0% interest, interest rates charged to the borrowers is about 4-80%, with a typical rate ~20-45% (also keep in mind that in none of the MFIs does Kivas 0% capital represent all of their capital needs). While Yunas doesn’t really get into it, from reading many of the journals and fellows blogs on Kiva, it seems that much of the benefit people actually get from microloans has as much to do with other services offered by good microfinance institutions than it does with the actual loan. Many of the MFIs for example offer or even require savings for a rainy day, they offer financial and/or business training to every borrower, they coordinate group loans and support groups between the members to offer life and business advice and support, some offer insurance, or basic medical care, or give business advice and agricultural training, etc. Those things, combined with the capital to apply their new knowledge, allow the borrowers to succeed. I think Yunas is very rightly concerned that once you sell shares of MFIs to investors only out to make a buck, not only do you risk having too high interest rates and risk predatory lending, but you also erase incentive to offer other services that are so beneficial and necessary to helping people out of poverty.

3. Jared Says:
   October 1st, 2010 at 1:33 pm

   I have a question regarding the preference / open bias towards lending to women. Is this the common practice in microfinance because it’s getting money to those most in need, or because statistically (?) women in developing countries are more likely than men to repay their loans, or a combination of both? I don’t mean to take issue one way or the other as to whether this is a sexist practice or not; in fact I can see that for either or both reasons lending to women might be the best way to empower poor communities in the short term. However, long term, are we hoping to also begin lending to men? If not, it seems like all kinds of problems could crop up (men marrying women just to access loans, honest and entrepreneurial single men being shut out of access to financing, etc) which could ultimately lead to significant backlash. Perhaps an implicit goal as microfiance evolves should be to figure out how to determine credit ratings of the poor, whether male or female, to eventually allow for equitable distribution of credit?

4. Fehmeen | Microfinance Hub Says:
   October 2nd, 2010 at 1:33 pm

   Firstly, amazing analysis of the issue. Secondly, I think the answer to your questions is simple – it’s OK to make money off the poor if the reward is shared with them as well (not just in the form of offering loans at lower interest rates, but something more).

   The Islamic microfinance model may not be mature yet, but it requires both parties to share gains and losses. In fact, if the lender simply provides money (as a silent partner) and the borrower processes the money into goods/services to earn a profit, in principle, the borrower ought to get a larger share of the gains.

   In that context, it’s fair for the rich to make money off the poor. But if you look closely, it’s only OK because the rich make money ‘with’ the poor, and not ‘off’ the poor.

5. AP Says:
   October 3rd, 2010 at 10:07 pm

   I haven’t read through all the comments to see if anyone has mentioned this yet, but there is a “middle ground” between Akula and Yunus: it’s called “program-related investments.” Funders — i.e., “rich people” — commit a certain amount of capital (such as to microlending), but then they receive their money back after a set period of time — i.e., when the poor people are able to repay it.

6. Asif Dowla Says:
   October 4th, 2010 at 4:44 pm

   @AP

   Yunus calls this social business or zero dividend business. He is already running two organizations built on that principle: Grameen Dannon and Grameen Viola. The first one is producing iron-fortified yogurt for the poor and the second one is producing arsenic free water. Both the projects are facing problems as the take-up of the products is rather low. Grameen Dannon is forced to use cross-subsidy: selling the yogurt at higher price in the urban areas to pay for the lower price in the rural areas to make it work. The Grameen Viola project is in a bit more trouble because poor people in Bangladesh do not want to pay for water. He has documented all these issues in his new book, Building Social Business.

7. Jonathan R. Says:
   November 13th, 2010 at 3:36 pm

   Please note the following report in the Financial Times:

   “Debt trap leads to despair for rural poor” (October 29) which describes the debt burden resulting from loans from for-profit lenders.

8. Rod Rooter Says:
   November 18th, 2010 at 11:14 am

   The Indian mf crisis appears to be deepening. It is the result of for-profit MFIs’ relentless pursuit of profit. Loans were churned out with little regard for the borrower’s ability to repay, and the methodology of many of these lenders had little to do with poverty alleviation.

   It would seem that the local loan shark was simply replaced by an institutionalized, more efficient version, ie a ‘microfinance company’.

   Muhammad Yunus was right. Debate over.