There are several recommendations (including mine) floating around for the Malegam committee on how to fix microfinance. However, when we reflect on the current crisis, we find that no recommendation or regulation could have prevented the current mess. There is no way in which one can mandate a business to operate in a certain manner. One can lay the rules and framework, but cannot mandate patience, compassion, integrity and satisfaction in a business.
If microfinance has to succeed, it has to be a patient business. Any business with a long-term view has to engage with clients; the well-being of a business lies in the well-being of its clients. The better off they are, the more do they do business, provide more profits and increase the business’ ability to reach out to newer clients. If organisations have a short horizon, they engage in rip-offs and quickly close shop. No business can be sustainable with clients being driven to bankruptcy or suicides. Many microfinance players have to figure out whether they want to be there, not only the next quarter, but for the next century — assuming that even as most of their clients have been drawn out of poverty, there will be a new benchmark of poverty.
Two inter-related and important things that the committee cannot deal with in concrete terms are:
- The quality and the orientation of the investments that are coming into the sector.
- The resultant quality of governance that it brings in.
The shorter the horizons the investors come with, the quicker will be the rip-off. In a business that deals with the poor, it should be anathema to talk about quick “exits”. But how does a committee mandate that in a market where capital flows freely? If we look at the general pattern, we find that the players converted a business of financing the poor who would bootstrap themselves out of poverty into a touch-and-go business. The question then is, do we need a different breed of investors for the microfinance business? This puts the curbs we have on investments in certain sensitive sectors (like insurance and retail and possibly microfinance) in perspective.
If we are dealing with the lives of the poor, given the fragile nature of their livelihoods, they should be insulated from the volatile expectations of the markets. Fungible capital in the global arena always finds an opportunity for arbitrage. Investments will freely move from one sector to another and from one geography to another. It is easy to argue that the more international the investors, the more mobile would they like to make their capital. However, in hindsight we find that the nationality of the capital is less important than the engagement horizons and return expectations.
Governance is closely linked with the type of investors and the performance parameters they establish. What do the investors mean by growth? When BASIX set up shop as the first mainstream commercial microfinance institution (MFI) way back in 1996, it received patient capital in the form of long-duration, rupee-denominated soft loans from developmental agencies like the Ford Foundation and Swiss Development Cooperation. Questions about profitability were invariably asked every quarter, but so were questions about the average client loan size figures, number of women clients and number of livelihoods affected. One instance is noteworthy. BASIX lent significant amounts to seed production organisers, because the activity was labour-intensive and a typical loan to such a party had a great livelihood multiplier. However, BASIX soon realised that this portfolio came with a caveat: the organisers employed girl children for a major part of their work. Would a typical investor have the patience to engage with this issue that represents, say, 5 per cent of the portfolio? Would the governance structure raise this? If not, does it have the potential to become a large ethical problem for the business?
When we look at the pace and valuations at which investments came in for microfinance, we realise the impossibility of what Malegam has to deal with. SKS placed shares at Rs 10 in 2006. The first issue of shares at a premium was in March 2007 at Rs 49.77. The public issue three years later was at Rs 985. There were issues at different prices in the interim. If investors were raising the value of entry every time, and with such a high magnitude, the expectation of returns would also be as significant. The rapid appreciation of the entry premium makes it quite obvious that there would be tremendous pressure on quarterly profitability to ensure that the market capitalisation does not fall. Would, then, such a structure have the patience and the courage to withdraw from an area where other (so-called rogue) MFIs are bombarding clients with more loans to newer areas? Or to deepen the relation with the client to ensure that they were the sole lender?
If the answer was no, then there was a failure written on the wall. The Andhra Pradesh ordinance (and now the Bill) was a blessing in disguise because it gave an escape clause and punching bag for what would have eventually happened. Not seeing the writing on the wall amounts to governance failure. How can this be mandated? Surely, the Malegam Committee can define “independence” of the board members, and define “conflict of interest”. There is no way a committee can mandate that these board members will exercise independence and safeguard client interests. Governance is not about just following the rule of the land, it goes much beyond this. Let us consider this: If a whole-time director wants to take an interest-free loan to exercise his stock options, assuming that there is nothing in the law that prevents it, what should be the board’s stand? There is no specific mandate that says the governance structure should, in fact, look at the obvious conflict of interest. The committee can fix this by building a mandate around this instance and this example. But a new dilemma would crop up tomorrow. The independence of the governance can only be demonstrated and not mandated. The regulation can, at best, prevent certain people joining the board on clear objectively verifiable indicators, nothing beyond.
Did BASIX escape this pressure for a long period because its initial investors were development-oriented funds like the Ford Foundation and the Swiss Development Cooperation, and, therefore, grew patiently applying the livelihoods triad than the touch-and-go model? If that is the difference, how can the committee mandate who the investor should be, and what horizons the investor should have and what governance structure the investment might throw up?
A while ago, the world hailed employee stock options as an innovative mechanism to buy in long-term employee commitment to the organisation. We have seen that once the stocks are vested, the employee horizon shrinks to a quarter. So no mandating through recommendations and regulation can change the need and greed of people. The task of the Malegam Committee is really impossible.
The writer is former professor, Indian Institute of Management, Ahmedabad