Vikram Akula, founder and CEO of SKS Microfinance, launched the company in 1998 to offer small loans to very poor borrowers. Some 10 years later, SKS has become India’s fastest growing microfinance institution (MFI), with more than two million borrowers. In the next two years, Akula would like SKS Microfinance, whose backers include venture capitalists such as Sequoia Capital, to grow to eight million borrowers — which would make it the world’s largest microfinance lender, surpassing Bangladesh’s Grameen Bank. In an interview with India Knowledge@Wharton at the recent Wharton India Economic Forum, Akula spoke about emerging trends in microfinance.
An edited transcript of the conversation appears below:
Knowledge@Wharton: Let’s start by talking about how you got into microfinance. Could you tell us a little bit about how and why?
Akula: Sure. I was born in India, but grew up in the United States. I’ll go back to my childhood here; I used to go back to India quite a bit during school holidays, and I would see the extreme poverty we have in India, and then come back to a suburb of America. It was that juxtaposition of extreme poverty, on the one hand, and extreme wealth that made me say, “Okay, I want to do something to try and eradicate this kind of poverty.” So upon graduating from college, I went and worked with an NGO, basically as a field agent, as a loan officer doing microfinance. I saw the tremendous impact that microfinance has on the lives of the poor, but I also thought that you could do it in a more scalable manner. That’s when I left that NGO to set up SKS, the entity that I now run.
Knowledge@Wharton: I know you’ve spoken in the past about some of the constraints that face the world of microfinance. For example, lack of capital is always a problem. Lack of capacity is another major issue. And, of course, microfinance also has high transaction costs. What innovations has SKS has been able to bring about to tackle these issues?
Akula: This is what I call the three “C’s” — the lack of capital, the lack of capacity, and the high cost of doing microfinance. In my analysis, these three constraints have prevented microfinance from scaling up rapidly.
We’ve done three things to deal with these problems that we think can overcome these constraints. The first is to use a for-profit model to overcome the constraints of capital. The second is to use best practices from the business world to overcome the constraints of capacity. And the third is to use technology to overcome the cost constraints.
Let me say a quick word about each. We believe that even though most microfinance institutions are non-profits — and even though Professor Yunus [Nobel laureate and founder of Grameen Bank], who’s a mentor of mine, talks about microfinance as a social business, meaning not paying dividends — we believe that in fact, you have to structure things in a for-profit way. You have to pay investors high dividends, because otherwise there’s no way you’re going to access the kind of capital that poor people need. As a result, we’ve structured SKS as a for-profit, and that’s enabled us to tap into commercial capital and provide unlimited amounts of finance to the poor.
On the second dimension of capacity, if you look at most microfinance institutions, they’re structured as NGOs. They’re small, they think about a thousand clients, or maybe 10,000 clients. In contrast, a business, whether it’s Starbucks or Coke or McDonald’s, thinks about millions or tens of millions of customers. We’ve looked at those types of companies and adopted the techniques that they’ve used within microfinance. That has given us an extremely fast growth rate.
Finally, when it comes to technology, we’ve developed an automated management information system because at the end of the day you’re doing millions of very tiny transactions. There’s a high cost to doing that. Unless you use technology, you’ll never be able to bring down the transaction cost and to scale rapidly.
Knowledge@Wharton: To tackle that last point first, I’ve heard you use mobile phones to manage transactions. Is that right?
Akula: We are doing a pilot project right now with mobile phones. Clearly, we think, mobile banking is the future; it doesn’t make sense to try and build a retail brick-and-mortar infrastructure in rural India. From a cost perspective, it makes no sense at all. Mobile technology today is robust enough that you can actually very easily do banking. We actually have a very successful pilot that we’ve done.
The problem is the regulatory environment. The central bank in India has not understood mobile banking and its full potential, and therefore their regulations get prohibitive for us. If those regulations get changed, then clearly this is the investment that we’d make. Mobile banking could be the future of microfinance.
Knowledge@Wharton: Let’s go back now, if you don’t mind, to your first point about getting funds from private sources. I understand that SKS has raised funds from venture capitalists. When they invest in SKS microfinance, does that change their expectation of returns? Are they more “gentle” with you because you are lending to poor women, compared to if they were to lend to, say, a technology entrepreneur.
Akula: We certainly have social investors, who come at it with a double-bottom line approach of making a social impact as well as a for-profit impact. But we also have investors who have a pure commercial interest. Take, for example, Sequoia Capital, the investors in Yahoo, Google, and so on. They’re not interested in the social purpose. They’re in there because their investors need to earn a high return, so they come in at a pure commercial angle.
Many people think there’s a dichotomy between the social purpose and the commercial purpose, but we actually don’t think there’s a dichotomy. If you do what’s right by the borrowers, if you charge reasonable interest rates, provide good service, not only is that intrinsically the right thing to do, but that’s the way to build a good business, especially when you are working with the base of the pyramid, because the base of the pyramid customer is extremely loyal. If they feel they are being exploited or taken advantage of, they will turn on you in a second. But if you treat them well, they will stay with you. That becomes how to build a long-term healthy business. That’s what our commercial investors want.
Knowledge@Wharton: Typically, what are the interest rates for microfinance loans?
Vikram: We charge an average interest rate of 24%. That seems extraordinarily high, but let me put this in context. Informally the village money lender, the loan sharks, will charge anywhere from 50% to as high as 1,000% interest. So, we are charging much less than what they charge.
I also submit that our interest rate is actually the lowest cost financing available to the poor. Even though a retail bank might charge, let’s say, 12%, or a subsidized government loan might cost 7%, if you actually talk with borrowers and ask them how many trips they are making to a bank branch, what are the lost wages, the bus fares, the brokers fees, and sometimes bribes are paid to access that 7% loan, they actually end up paying much higher than 30%.
So, at 24%, we are asking the lowest cost financing available to the poor. The poor are earning such high returns on their micro enterprises that they have no problem paying 24% if their returns are averaging 100% or so.
Knowledge@Wharton: It sounds like the rates you charge seem to be lower than those that credit card companies charge people here [in the U.S.].
Akula: That’s true.
Knowledge@Wharton: Knowledge@Wharton had interviewed Muhammad Yunus sometime ago. He brought up an interesting point — perhaps because of the situation you are describing, he argued that some microfinance companies might need to be regulated because of the exorbitant interest rates they charge. Do you agree with that perspective?
Akula: I think the best way to tackle interest rates is competition. Certainly in some areas you’ve got microfinance institutions (MFIs) that are trying to extract and charge high interest rates. Over time, you will see competition pulling that down. When we compete in different areas, the first thing we see is the local incumbent MFI will immediately drop its interest rates. We think that’s the best way to do it. We wouldn’t be in favor of regulation that caps interest rates. We are afraid that will prevent other competitors from coming in and prevent the more robust way of lowering interest rates. Still, there is a scope for regulation when it comes to ethical practices, such as truth in advertising, and transparency with your borrowers. Those are the types of things that will make a big difference to making sure that the sector remains healthy and prevents the bad apples from coming in.
Knowledge@Wharton: As you’ve gone about building SKS Microfinance, what has been your single biggest challenge so far and how have you overcome it?
Akula: The biggest challenge so far, and clearly the challenge going forward, is the political environment. The fact is that microfinance is still very much misunderstood by politicians and bureaucrats. People hear the interest rates, and they don’t understand the context, and they feel something exploitative is going on.
We spend a lot of time trying to educate politicians and bureaucrats so they understand the power that microfinance has and understand how it works to actually help the poor. The poor certainly understand this, our customers do. They come back to us year after year. It’s the political elite that doesn’t understand it and sometimes misuses microfinance for political ends. That’s been the biggest challenge.
Knowledge@Wharton: How many customers do you have, and who is your typical borrower?
Akula: Currently we have two million customers spread across 25,000 villages in 15 states of India. The typical borrower, typical first loan is about 8,000 rupees or about $200. A woman might take a loan to buy a cow, and then sell the milk, and then repay the loan on a weekly basis. She might do a small village grocery; she might do vegetable vending or another type of trading activity. What we see is there’s a very high return on investment, and each year she’s eligible to take a larger loan. So even though $200 might seem relatively small, eventually we’d like to see borrowers moving into $1,000 loans. Then you begin to see huge impacts in terms of poverty eradication.
Knowledge@Wharton: Where do you see SKS being five years from now?
Akula: I’ll give you our two-year goal. We have close to two million clients now. We hope to scale to eight million clients in the next two years. Today we are largest MFI in India. If we hit that number of eight million, we will become the largest MFI in the world. In terms of scale, that’s one thing we would like to do.
We also have a vision to use microfinance, the channel we’ve created, to distribute the full range of finance services. Now we do primarily credit, and some insurance, but we know poor people need savings, they need remittances, and the other products as well. We want to introduce a range of different products.
We also think there are opportunities to leverage this channel to introduce non-financial products as well. So, currently, we’re in discussions with groups about doing education loans and talking with education providers to provide low-cost schools. We have a health insurance product that we are teaming up with local hospitals. We are giving loans to buy cell phones, to buy consumer package goods. We think there is a whole range of non-finance products that poor people need that we could deliver through our channel.