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Mr Akula's exit

Microfinance firms pay the price for following a flawed model

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Business Standard New Delhi
Last Updated : Jan 20 2013 | 2:43 AM IST

It was only in 2006 that an American news publication nominated Vikram Akula as one of “the world’s 100 most influential people”. His exit from the company he founded, SKS Microfinance, only underscores how correct the publication was. He has single-handedly influenced one of the world’s largest microfinance markets in such a manner that it will take the sector years if not decades to recover. Before Mr Akula entered the sector, microfinance in India was largely the preserve of non-governmental organisations or NGOs, which used financing as a livelihood-enhancing tool. While some of these NGOs realised that aid funds were drying up and began turning into non-banking financial companies in order to access commercial funding from banks, it was Mr Akula who gave this access a completely different meaning.

His international education and connections were probably the reason why he felt he could emulate the highly successful private equity path of Compartamos of Mexico. SKS, initially established as an NGO, worked with donor funds. The process of turning into a commercial entity started in 2003. Over the four years that followed, a series of private investors, excited by the company’s phenomenal rate of growth, put equity capital into the company. Its portfolio increased from just over $20 million at end-March 2006 to around $960 million by end-March 2010, a compound growth rate of 161 per cent per annum. The number of its borrowers grew from just 173,000 in March 2006 to 5.8 million in March 2010 — a compound growth rate of 140 per cent per annum. The path for an initial public offer (IPO) had been obviously paved.

But instead of being alarmed at this pace, other players in this sector, with their eyes too on IPOs, felt they needed to emulate this. In fact, calculations by Micro-Credit Ratings International Ltd (M-CRIL) show that growth of microfinance institutions (MFIs) in India during 2009-10 was 61 per cent in terms of the number of borrowers and 88 per cent in terms of portfolio. In this scorching pace of growth across the nation, livelihood ideas were of course the first casualty. Scant attention was paid to what productive use the borrowers could put these loan funds to. Administrative costs came down as volumes increased, and borrower research was given the go-by. Weighted average return on assets of the ten largest MFIs in India during the financial year 2009-10 was as high as 7.9 per cent, and 6.8 per cent for the larger sample of 65 MFIs studied by M-CRIL, compared to 2.1 per cent in 2005.

Instead of passing on the benefit of lower costs to poor borrowers, as was envisaged by the visionaries of this industry, microfinance companies started to reward investors and employees better. In true mainstream financial sector style, more hours were spent on board meetings discussing sweat equity formulas than new livelihood concepts. A study that documented and analysed the equity valuations of MFIs worldwide found the median price to book value ratio of equity transactions involving Indian MFIs (at 5.9) to be by far the highest for MFIs in the world. Investors were swayed more by the expectation of future profits than by historical returns. And the gains to be made from 140 million financially excluded families made investors’ excel sheets look attractive. The Andhra Pradesh Ordinance of October 2010, which was brought in to protect borrowers and put severe restrictions on microfinance companies, pricked this bubble of greed and brought on the crisis in the Indian microfinance sector. Mr Akula did wield his influence.

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First Published: Nov 25 2011 | 12:17 AM IST

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