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

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: