Should microfinance institutions go public?

This week Indian markets and banks and corporates were rocked by a new moral debate. The SKS IPO raised several questions about private profit and public benefit and the links between the two.

For years microfinance conjured up the image of hard working, sincere social workers. Will the profit culture of the stock markets fit the clientele of the Micro Finance Institutions?

Two insiders of this industry, Ramesh Ramanathan chairman of Janalakshmi financial services and Vijay Mahajan the founder promoter of microfinance institution Basix join to debate the issue in an exclusive interview with CNBC-TV18.

Here is a verbatim transcript of the interview on CNBC-TV18. Also watch the accompanyin video.

Q: Are you convinced that the stock market is the route to raise more capital, do we expect you to follow in the foot steps of SKS?

Mahajan: Having an IPO is inevitable beyond a certain size for any corporation because when you have to raise capital say beyond Rs 300 crore - Rs 400 crore per annum there is virtually no other source and you have to go to the capital markets so a USD 100 million per annum is the threshold. Now it so happens that Basix is below that size but I am sure that we will get there fairly soon may be in a year or two. So it is inevitable that anybody who grows will have to have an IPO.

Q: So you don't have any ideological issue that the stock market culture could distort the way in which your social enterprises run, you don't have a problem that social benefit could get kind of adulterated by the need to prove profit which is what stock markets want?

Mahajan: Its true, but the stock markets basically reward steady performance, good governance, transparency and so on, you have companies like the HDFC which have for decades raised money and have done very well for their customers and so many others in other sectors, so I don't see any connection between having to reduce our service level to our customers and being in the stock market.

Q: I know from having heard you on the issue that you are not against the profit motive itself but you did tell me last time that you have a problem with the ESOP's culture what is your problem, where do you think the balance must be struck?

Ramanathan: First thing we need to do is to establish, just because somebody is working with the poor doesn't necessarily make that enterprise a social enterprise. Let me cite the example of Hero Cycles, Mr Munjal began by selling bicycles to the poor. There are companies like Unilever where the sachet culture was created specifically because the poor was a potential target market and they created a product that could be appealing to the poor. So just creating products and services that can work for the poor doesn't necessarily mean that those become social businesses in fact those are pure commercial businesses and nobody has any problems with those.

So no one is accusing Mr Munjal or Unilever or anybody else who are targeting products at the poor of being some how morally compromised. The issue comes up when we say we are not just a pure commercial enterprise, that we are actually a social enterprise and then the behaviour seems to suggest that those are not consistent which means we need to ask the question is there more to a social business than just the profit motive and if so what are those things and how does the enterprise actually protect those and promote those and here's where the issue comes. When somebody wants to set it up as a social business and harness the part of the market there are tremendous benefits that come from harnessing the part of market innovation, capital, scale the ability to recruit people and so on.

But it comes at a price and that price is that the markets are driven by money and wealth creation and that price we need to recognize acknowledge and somehow protect against because if we open the door of the social enterprise the danger is that this double edged sword of the market can overwhelm the social intent and that's where the issue comes up. So one example of this can overcome is in the question of ESOP's, it's a very normal practice in a commercial enterprise, there's nothing wrong with saying that somebody has equity and then when you hire a new CEO you give them stock options but imagine what happens in a social enterprise when that takes place, the CEO gets stock options, the next rung of management says why should I come and work every day till I get a skin in the game and pretty soon you have the entire enterprise actually oriented towards share price and their mark to market value and their wealth creation and I am not saying that it will but I am saying that there is a danger that, that culture can erode the social component of the enterprise not as market driven aspects which are a good thing.

Q: Alright your point is taken its really a difference in degree and not questioning the stock market itself but there will be other issues that will come up, you may be charging your clientele 30% but with that money they are almost able to double it so 30% per se is not is usurious but externally it might seem that way and when you are in a situation where you are presenting your profits or if there is in some district a political or a social or an economic problem chances are that this could become a fodder for political or for some kind of unrest. Is it possible that these institutions can quarter after quarter continue with the profit motive there could me some kind of social unrest question?

Mahajan: The issue of interest rate is something that micro finance institutions have to constantly answer for and basically in a nation where 70% - 80% of the banking assets are in the public sector and public sector banks are able to subsidize loans at the lower end of the market. I was in Maharashtra last week for example and now Maharashtra framers will all get 0% crop loans so compared to that even a 6% loan would look usurious but if you are talking of realistic pricing then the thing to look at is what MFI's are doing and while it is true that politicians and even left intellectuals - kind of people keep attacking MFI's but when you do the math's with them they concede, I once had a hearing with parliament standing committee on finance and it took me 10 minutes to explain to them why it is 24% and several of them at tea time came and said why don't you come and work in my constituency.

So we have got to make a choice as a nation between perpetually subsidizing certain sectors whether it is power or Kerosene or credit or building a robust set of enterprises which are self sustaining and which by the way they compete with each other will bring down even their margins. So right now what you are seeing incase of SKS is the pioneer getting an extra-normal profit and there is a curve which will go down over a period of time and by the time the 5th or 6th IPO happens it will be a stable equilibrium and that's how all sectors get built so I really think that we are sort of exaggerating the point because this sector is suppose to take care of working with the poor. Having said this I also want to say that I do draw a line between the institution being profitable enough to attract capital on and ongoing basis and personal enrichment for the founders or the initial promoters and indeed the current CEO's and so on.

Q: All companies benefit with good corporate governance and that's pretty rare in India, I mean you will always get a higher valuation for an Infosys simply because corporate governance brings in that dimension. But in Micro finance corporate governance needs to be even more careful because of the nature of the clientele, what would be your tool kit, what would be your 2 - 4 golden rules of corporate governance that need to be maintained?

Ramanathan: I think you hit the nail on the head. I think that part of the bar that needs to be placed on micro finance institutions is an extremely high bar on corporate governance, there are few things there are basic tenets in pretty much any industry but might be more applicable or more acutely focused on in the micro finance sector. First is transparency on the complete pricing, cost curves, the total fee structure so that you get to understand the economics of this. You talked to Vijay about why is it that interest rates are being charged so high and Vijay gave a very compelling answer I think its important that, that gets published out into the public domain so that the public at large whether its media, whether its regulators, whether its investors get to understand the structure of cost of micro finance institutions. That has two benefits; one is it helps to focus attention on one of the critical components of cost which is operating costs, it's in double digits. Overtime, as scale becomes evident one of the advantages of MFI's that can scale is that those operating costs go down and that can be tracked. The other is very importantly independent members of repute on the governing board of the micro finance institutions that's going to be a critical aspect of transparency and accountability. That would be a good signal for MFI's to send to the investor community as well as regulators and media.