Since 2006, you have seen a fledgling SKS Microfinance, which is now Bharat Financial Inclusion, grow leaps and bounds despite countering several challenges in the form of Andhra Pradesh-led microfinance crisis and more recently demonetization. What are the key strategies and learnings that helped you in such critical times?
Microfinance started attracting limelight after Prof Yunus got the Nobel Prize in 2006. Vikram (Vikram Akula, founder of SKS) got nominated in Times Magazines top 100 people list during that time only. Private equity had started coming in in 2006, Sidbi (Small Industries Development Bank of India) invested too. Just around the time I joined, the company was in the process of raising equity.
Between 2006 and 2010, it was all about scalability. Universally all the microfinance practitioners started with great intent. They continued with the narrative saying “we are here for a social cause”. But the underline fact was, as a non-banking finance company, all started seeking private equity and making profit. Fundamentally, the narrative of this being a social business was eliminated with our IPO at high value. People realized that there is so much money that can be made. Vikram’s philosophy was to make profit but without trying to be extremely profitable. He focused more on efficiency, computerization. But when the crisis started, we were beaten black and blue. But where we stood out was: first, our geographical diversification with healthy 70% portfolio outside AP and second, that we raised capital through IPO so we had enough cash. We were also quite vocal from the AP crisis days that nobody should go and lend individual loans without proper system in place, we are against going for high-ticket loans and monthly repayment schedule. These are where the trouble begins.
You were a banker earlier. What has brought you in this sector?
I had previously worked in companies such as DCL, Esanda (a part of ANZ), Standard Chartered Bank, and had two entrepreneurial stint in between. I joined ING Vysya in June 2004 (Bangalore was the headquarters of the erstwhile ING Vysya Bank). My family was here. In a visit to Hyderabad to meet my family, I called Sitaram Rao, my professional mentor. That time he was in SKS Microfinance and had invited me to visit SKS, which had 40-odd branches and some 40000 customers. I thought there could be a lot of cross sell opportunities. So, I tried to convince him to become a channel partner for insurance. He told me to do a field visit and check out whether customers can afford insurance. I did and I was swayed by the business model and it’s potential. Eventually, I started chasing him for a job in SKS. They were an NGO at that point in time. In 2005, it got converted into a non-banking finance company and I finally joined in 2006 after two years of chasing Vikram (Vikram Akula, founder of SKS) and Sitaram Rao. The sector was not too crowded then.
How were those days in 2010, when everybody in the microfinance industry was taken by surprise by Andhra Pradesh government’s decision to ban MFIs?
Signs of things becoming different started in 2008-2009 when we saw changes in customer behaviour. They started demanding more, thanks to the attention microfinance industry got after Nobel Peace Prize and stuff like that. People saw that this was a 99% repayment business and started getting into the business. In the span of one year, the whole landscape changed. Instead of four or seven, you suddenly had some 20 people coming in.
Normally, in a heavy competitive business, pricing comes down. In this space, given the fact that there was no system and credit bureau, people could grow 60-70% without competing on price.
Andhra Pradesh at that point had the maximum portfolio as four MFIs had headquarters here. Even money lenders started calling themselves microfinance companies. It was becoming a joke. All came to a boiling point because Andhra Pradesh had the strongest SHG (self-help group) portfolio. The Society for Elimination of Rural Poverty (SERP) was a great institution but the problem was they suddenly saw their portfolio getting shrinking and repayment getting affected. Politically, when YSR (YS Rajasekhara Reddy) was chief minister, there was lots of controversy but YSR allowed MFI to operate. But after his passing away and when Mr Rosaiah became the chief minister, the act was passed. That was immediately after our IPO.
First day we did not even understand what was this all about. In the second day we thought we will fight it out in the court. But over a period of 15 days, we realized the government was very adamant and determined and was going after us like nobody’s business. In two months, it was like a deserted field with no one working. Even if some borrowers wanted to repay, there was nobody to collect it.
When the crisis started, we were all beaten black and blue. What saved us was our diversified spread across the country. We had learnt from AP days that if you have strong processes, if you are disciplined, are following the group liability model, lend loans of small-ticket sizes, and ensure that the loan is for income generating purpose, you can avoid a lot of trouble. We stick to weekly repayment because that had paid off during the crisis.
I am not saying that there was nothing wrong in the MFI industry. When people started masquerading the process then there is going to be an issue… harsh collection practices and stuff like that. But the problem the government made out was far far exaggerated than what it happened actually.
What are the benefits of weekly repayment?
Weekly repayment means smaller instalments. It mimics the cash flow of the rural borrower. They don’t have cash holding capacity for one month. Particularly in rural areas, borrowers have holding capacity at best for a week. If there is cash in hand, it typically gets consumed. In urban areas where bank is nearby, they can still hold money or park it to banks.
The microfinance industry has come a long way from the time of Andhra Pradesh crisis. The sector now has government backing and regulation by its side. Yet, perhaps no one can deny that the sector still has a fragile eco-system. Does high growth in successive years make you concerned?
We have raised this issue internally. Whatever is the growth rate, we have decided to cap our returns at 3% ROE (return on equity). Secondly, we have to drive efficiency and became the least cost provider. In a sense, AP was good because it brought a method to the madness, had forced people to introspect.
When we raised QIP in September (2016), we kept saying to every investor that there is unbridled growth in the industry and there could be a shake out. We had no idea in what form will it come. When shake-out happens, people with good processes survive. People with loose practices and aggressive lending practice take hit. So when demonetisation happened, some people called me having a black tongue. Some people say you are prophetic. But the fact remained that people who didn’t follow the processes have paid a price for their aggression.
What is the repayment situation now? When do you expect normalcy to be restored?
It’s improving. Counter intuitively, whether in Uttar Pradesh or Maharashtra, our repayment has improved post farm loan waiver. One hypothesis could be that, people start thinking that they don’t need to repay farm loan and so they are clearing their dues to MFIs to get fresh loans.
I expect normalcy in another six to nine months. We have guided the market that we will make Rs 435 crore profit on Rs 14000 crore loans and we are sticking to our guidance. We have provided for default loans in March and the next half of provision will happen in June. So, September onwards we will start showing profit. In the March number, we have provided for Rs 335 crore but out of this we are getting repayments. It’s anybody’s guess whether this 335 will go to 380 or will come down to 300. In a worst case scenario, we may have to write off Rs 360-380 crore and in the best case scenario, it would be Rs 300 crore.
Meanwhile, we are continuing with customer acquisition and disbursement wherever repayment is good.
How do you plan to compete with small finance banks which can access low cost funds by the virtue of being banks?
As a standalone basis, we don’t see this as a concern. For a variety of reasons. Today, you take the rate of interest of each small finance bank. We are much lower than any of them. They have to travel a long way. Our belief is, this small borrowers segment is not going to give you large scale deposits. These banks have to be in urban markets for bulk deposits, they have to go to big institutions and high net worth individuals. It will be a limitation because when you go for bulk deposits you have to pay higher rates. All the small finance banks are also paying 1-2 percentage points higher on savings deposits. Plus, today they have to spend a hell lot of amount on infrastructure, on the core banking solution. By the time they pull this off, our RDSP (retail distribution and service point) model will be ready and we will be streets ahead of everybody.
Philosophically, microfinance model is based on good repayment, our regular interaction with customers. Growth can come through more and more fresh customers. The landscape is changing with financial inclusion, government pushing cashless transaction and stuff like that.
In the hindsight, are you happy now that you didn’t get the small finance bank license?
We have taken it in our stride. The RDSP was part of the primary plan. It would have given us more wherewithal to get everybody to open bank accounts and do all transactions. That’s why all the chatter about IndusInd Bank and the merger and stuff like that. Ultimately we believe that either you have to be a bank or part of a larger bank. Or, we will need to get a bank to open 65 lakh accounts and 2 lakh kirana store accounts. So, we need a bank as a partner, with or without stake.
Is IndusInd Bank a more likely partner among the suitors?
The decision as to which bank or which entity or whether there could be a non-bank partner, would be based on what they are offering on table. What is the value for the three stakeholders – the customers, shareholders and field level employees? I am not talking about the senior management. The entity which agrees to take all the field level stuff, which would not sack any people in normal course, bring value for shareholders, would be chosen.
The question of employee protection arise if and only if there is a merger. You would not need to worry about these when a strategic sale happens? Which is the most likely possibility?
We are open for all possibilities. It’s difficult to say at this point which possibility is going to take place. The point is, we have an independent board. This is going to be a very big decision on behalf of shareholders and employees they will be getting. It is important to take a 360 degree view on this. Just because there was an offer, we don’t want to take it. So, it could be a merger or a 10% stake purchase by a bank or 20-30% stake purchase by anybody.
What we are looking at is, that when we graduate into the individual lending, our average ticket size will increase. Perhaps we will have 10% of our business in housing loan with average ticket size of Rs 1.6 lakh, and may be 10% in books in two-wheelers. So, the scale of the game will change. Our book will grow from the current Rs 9000-odd crore to Rs 40,000 crore. So, we need somebody to anchor this. We don’t have any anchor investor or a parent as of now. The fundamental assumption for us while doing this RDSP that everything will be done through bank accounts.
Is there a fourth bank in the scheme of things?
Let that be in the wraps. We have been so transparent. There is one more player but beyond that I would not say anything. Transparency ends here, I say (laugh).
You mentioned several times that you need a bank for the success of RSDP. Can you elaborate please?
In 2007, we did a pilot on cashless transaction with a company called A Little World. But we realized that customers can’t remember the pin and we dropped it. We wanted a technology which is not dependent on customers’ memory and hit upon the RDSP model one-and-a-half years back. When Aadhar Card started scaling up, we decided to make everything Aadhar number based. We are piloting a model where kirana stores in villages will become cashless transaction point for loan disbursement, repayment, depositing money in a bank. With the use of your thumbprint you can even purchase a bottle of water or anything from a kirana store. Essentially what we are saying is we want to eliminate cash from the centres. You make any transaction, your account will be credited or debited and you will get sms-es. We are also telling our borrowers that if they have excess cash, park it in bank accounts through kirana stores. If they want to buy something, they can get it from the kirana store in cashless mode as well, and the money will be debited from their account. For us the gameplan is, if we execute well, if all our customers are repaying through kirana stores, we will have the data on repayment and their savings habit. So after one-and-a-half year, we can have all records of their cash flow and what their savings are. So, 50 lakh customers and repaying loans 50 times a year, so we will have tons and tons of data with which we can do analytics and track best customers. Now we can go to customers and offer them two-wheeler loan, or a home improvement loan up to Rs 5 lakh. We have already started a pilot in two wheeler loan, without any data, just based on their repayment track record. We are also planning a pilot with in the housing segment. We will start two wheeler or housing improvement loan, by the time Ritesh’s (Ritesh Chatterjee, chief of operational excellence) team is ready with the data.
About eight lakh of our borrowers run kirana stores. We would like to convert two lakh of them as cash transaction points.
But why are you taking this effort to track customers. Isn’t credit information bureau doing it anyway?
In MFI industry, standard repayment is 99%. Say, all the members are paying, but we don’t know which member is paying from her pocket and which member is borrowed from somebody. Credit bureaus do not have this detail. Even reports from our sangam (field) managers are mostly anecdotal. Kirana store model eliminate all these anecdotal stuff. When we will have hardcore data on customers’ financial behaviour without any assumptions, we can move out of joint liability model of lending and do individual lending. Joint liability model will be used only for new customers.
What are the challenges ahead for the microfinance sector?
We need to address the concerns of larger stakeholders. And everybody is a stakeholder for microfinance. The government, local bureaucrats, local politicians. The chatter we always hear is about over lending, harsh recovery practices, and excessive interest rates. It is in the interest of the industry itself to work to remove these apprehensions. Today banks are equally in the space as much as we are. We should have bank representative on MFIN board. Independent directors in MFIN should be people who the industry, with no conflict of interest. The perception largely today is that MFIs continue to charge high rates of interest. How many people have reduced interest rates in the past, what are their efficiency levels? That’s the big challenge. I am not saying that if we go to town saying we are charging 19.75%, which is the lowest in the industry, people will clap. There will still be a lot of people who will continue to say that we are charging very high. If we do this RDSP, become cashless, and become more efficient, we will be creating a space to reduce interest rate by a couple of percentage points. Somewhere you have to convey the expression that we are taking every effort to reduce cost to the borrowers, listen to borrowers grievances. It can’t be only intent. It has to be seen in action also.