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Entrepreneurship - BLOG

Capitalism: Making Altruism Sustainable

Amitava Chattopadhyay, INSEAD Professor of Marketing |

Those with a genuine interest in helping the poor can apply capitalist principles to understand the needs of the market and provide it with what it needs.

The advent of microfinance has changed the lives of many in developing countries. The provision of microloans to low income borrowers with little or no records or access to formal financial services has pulled millions out of poverty. In rural India, a small loan of a few hundred dollars can enable even the poorest borrowers to become entrepreneurs. Farmers can buy tools to make their work more productive or industrious homemakers can buy sewing machines and start a small textile business, generating more income to pay the loan back and increase their wealth.

Microfinance was popularised by Nobel Prize-winning Bangladeshi economist, Muhammad Yunus, who founded Grameen Bank. Grameen sparked the boom of an industry and while microfinance originally used donations for its lending, the industry had to stand on its own two feet as there simply was not enough charity to keep pace with growth in demand. But the industry only became financially sustainable by charging high interest rates (as high as 35 percent in India).

This isn’t as outrageous as the headline interest rates suggest, as the cost of servicing such loans is significant. With uncertain income streams among its borrowers and undefined risks, microfinance institutions collect repayments on a weekly basis and do so at the borrower’s door. Add the fact that India’s prime lending rate is 7.5 percent and it’s not unreasonable for a financial institution there to charge high rates to cover its costs.

Nonetheless, this has led to accusations that microfinance is not helping the poor, and even that it is contributing to more suffering for low income borrowers who get caught up in debt due to uncertainty in their income, especially as not all borrowers are as entrepreneurial as the ones who reach the newspapers. 

Altruism at its heart

One microfinance organisation called BASIX, reflected on this and asked itself the hard question: Are we helping or hurting our borrowers? The answer to this question saw the turning point for the company that embarked on an ambitious and altruistic mission to support borrowers beyond credit.

BASIX, as we discuss in this case study, was started in 1996 by Vijay Mahajan, who had acquired a passion for rural development while doing his MBA at the Indian Institute of Management in Ahmedabad. He went on to spend a decade working for NGOs and government agencies. His work exposed a shortage of credit to the rural poor but also crucially, an absence of support, such as training, product design, market linkages, market infrastructure and producer organisations.

Before starting BASIX, he travelled to Bank Rakyat in Indonesia, and Grameen Bank and BRAC in Bangladesh to study ways to make microfinance more helpful with training. While at BRAC, for example, he learned that the organisation ran a bull station to improve cattle breeds for farmers on its programmes and microfinance loans, as well as a dairy plant for milk processing and marketing.

By 1997, BASIX had 15 staff and 12 customer service agents. The company experimented with agricultural produce market-yards and large scale non-farm enterprises among others to assist its borrowers. But by 2000, financial services were the core of BASIX’s work and in 2002, the company carried out an institutional assessment to understand what it was doing wrong or right. The leadership was dismayed to discover that only 52 percent of its 3-year microcredit customers reported an increase in income, 23 percent reported no change and 25 percent actually reported a decline.

While the main reasons for these figures were clients’ unmanaged risk, low productivity in crop cultivation and livestock rearing and an inability to get good prices in markets, it was clear that lending alone was inadequate to get people out of poverty.

The livelihood triad

The study gave Mahajan the impetus to move BASIX towards an integrated, comprehensive approach to the complex livelihood problems of the poor, which he dubbed “the livelihood triad”. This comprised of financial services, agricultural and business development services and institutional development services. While all three elements had been within BASIX from the beginning, those outside financial services were not on an equal footing. Now all three elements were equally important in the overall strategy.

BASIX morphed into a livelihood facilitator to solve the problems of its struggling customers. To become useful to less enterprising customers, it decided to start such customers with savings and insurance products before they could borrow microcredit. This would cover risks such as the breadwinner dying or cattle and crop damage due to weather or other externalities.

Besides lending in rural areas, BASIX organised agricultural and business development services into groups, associations, cooperatives or producer companies. Non-financial services piggybacked on existing delivery channels, avoiding extra expenses. And it supplemented its income with action research.

Crucially, BASIX’s microfinance arm charged its customers for its agricultural services and its bank, KBS LAB provided technical assistance and support for agriculture and business development. Field staff, who already existed, were able to advise clients. So not all arms of the organisation were profitable, but by creating an ecosystem to help the end-consumer to improve their livelihood, BASIX was able to fulfil its first goal of helping the poor, but secondly, to do so profitably.

Challenged on the ground

BASIX essentially constructed a portfolio of companies by testing and learning along the way but it was difficult to reconcile it with mainstream investors. This was reflected in its challenges with retaining talent and attracting capital. The highly experimental approach to its work had given its staff excellent exposure, which made them appealing to emerging competitors. On the funding side, the diffuse nature of BASIX’s work made valuation complex as investors prefer simpler models.  

Such organisations often get themselves between a rock and a hard place trying to prove that every part of the operation is profitable, but in the case of BASIX, it has been able to improve the lives of its customers and help them scale with a balanced ecosystem approach. While it charges for its assistance, it does so at reasonable pricing (Rs300 per year for agricultural services such as soil testing and advice on seed) and supports those in difficulty with a different set of products that keep them long-term. While investing to make a social impact takes time, applying capitalist principles is not only possible, but profitable.

Amitava Chattopadhyay is The GlaxoSmithKline Chaired Professor of Corporate Innovation at INSEAD. He is co-author of The New Emerging Market Multinationals: Four Strategies for Disrupting Markets and Building Brands. You can follow him on Twitter @AmitavaChats.

Comments
Milford Bateman,

This INSEAD case study paints an upbeat picture of both microfinance and BASIX which is so astoundingly divorced from reality that one wonders if it was penned by Mr Mahajan himself. As everyone knows, BASIX was one of the ‘big six’ Indian microfinance institutions that dangerously inflated the microfinance sector in the state of Andhra Pradesh mainly in pursuit of the largest possible financial rewards for its CEOs/owners, and then stood back like the proverbial rabbit in the headlights when it all crashed around their heads in 2010. The author of this case study does not refer to this boom-to-bust happening at all, which is a bit like a case study of Lehman Brothers that omits not just the events of 2008 but also the key details behind the events of 2008. The author refer to anything by India’s leading microfinance analyst, Ramesh Arunachalam, which exposed India’s microfinance for the sub-prime-style disaster that it was and, notably, how BASIX was right in the middle of this horrendous mess :

http://www.amazon.com/Idea-Which-Went-Wrong-Microfinance/dp/1494792486

The author might also have cast a glance at my extended review of Arunachalam’s book in Development and Change for details of how damaging microfinance was to India’s poor and how so many outside analysts, investors and academics made millions of dollars from India’s poor under cover of 'resolving poverty';

http://onlinelibrary.wiley.com/doi/10.1111/j.1467-7660.2012.01804.x/abstract

Surely INSEAD (and all other) case studies should be about honestly informing and stimulating students to critically think, not crudely propagandising for capitalism?

Amitava Chattopadhyay,

Microfinance is an essential part of the equation for the eradication of poverty. Without microfinance, many poor people have to turn to moneylenders who charge usurious levels of interest and it is this indebtedness that has caused massive hardship for the poor and indeed many of the suicides that have been reported in the media. Having said that, It is also true that some MFIs have undertaken activities that are unsavoury and unfortunate, to say the least. However, it is not appropriate to paint the whole industry as evil because of the misdeeds of the few, particularly in an industry which is by and large a force for good.

Coming to BASIX and Vijay Mahajan its founder, there is no evidence to suggest that BASIX ever undertook the excesses and practices that some of the members of the industry undertook, which is at the heart of this comment. Vijay Mahajan got dragged in to the storm as a result of being the Chairman of the industry association, Microfinance Institutions Network, and an acknowledged pioneer and leader in this sector in India; it was not because of anything BASIX did or was accused of doing.

To end, let me point to a case study published on this topic in Vikalpa (http://www.vikalpa.com/pdf/articles/2012/Pages-from-Vikalpa374-113-127.pdf), the journal of the Indian Institute of Management, Ahmedabad and to a quote therein from an article written by Vijay Mahajan in the Business Standard on October 16, 2010: “More disturbing are the recent reports alleging that some poor women have committed suicide due to the burden of over-indebted- ness caused by MFIs. If even one of these cases is true, it is a matter of shame for all of us in the sector. Though we should not give up on the principle of sustainability and thus cost- covering interest rates, the greed and ambition of promoters/ CEOs should not be allowed to convert a boon into a bane for the poor.”

Milford Bateman,

I’m afraid your response is entirely confused and fails to explain the many misrepresentations and factual errors in your case study.

First, you appear to claim that the poor still go to moneylenders, and it is this fact that has got them into massive indebtedness all over the world. This is a million miles away from reality. In fact, from Peru to Mexico to Bosnia to Bangladesh to South Africa to Cambodia, the poor actually got sucked into engaging with microfinance institutions not moneylenders. Remember that microfinance was said to be ethical and more socially-responsible than the money-lender, and yet the poor got into far far deeper levels of over-indebtedness than they ever did through contact with the old fashioned moneylenders.

Second, I agree that not ALL microfinance institutions allowed or encouraged their poor clients to go into way too much debt, with adverse consequences for them at a number of levels further down the line. However, the key point here is that the major microfinance institutions in India, very much including BASIX, all did this. Please consult the book by Ramesh Arunachalam, India’s leading microfinance specialist, who describes the ‘big six’ microfinance institutions as the guilty parties in inflating the unsustainable microfinance boom in Andhra Pradesh that burst in 2010.

Third, you also claim that the microfinance industry is ‘a force for good’. Well, I am afraid you are at least five years behind in your research since in the last few years even one-time advocates now accept that microfinance has not had any net positive impact in the community. For instance, the Centre for Global Development's long-standing microfinance advocate, David Roodman, was forced to concede in 2012, which was that "On current evidence, the best estimate of the average impact of microcredit on the poverty of clients is zero". If microfinance has zero impact on poverty, you need to be more clear as to why it is still a ‘force for good’. Are not the massive sums invested into microfinance depriving other better interventions of cash, such as health, education, infrastructure, SME development, etc?

Fourth, your understanding of BASIX is also ludicrously way off mark. BASIX was one of the most important forces behind the microfinance over-indebtedness damage in Andhra Pradesh. BASIX was one of the fastest growing microfinance institutions from around 2006 onwards, and while knowing that saturation was being reached it refused to halt its expansion when it could have done so. Even worse, its founder and CEO, Mr Vijay Mahajan, was on various Indian government committees and so knew full well that the situation overall was getting out of control, but he still refused to slow BASIX down and its explosive growth continued until 2010. Ramesh Arunachalam very clearly names BASIX among the ‘big six’ that brought on the Andhra Pradesh crisis.

Fifth, you also say that Mr Mahajan was Chairman of MFIN (Microfinance Institutions Network) formed in 2009, which is true. But you conspicuously fail to point out that while in this position in 2009-2010 he publicly claimed to be searching for the ‘black sheep’ microfinance institutions that were recklessly over-indebting the poor, yet the worst transgressors were MFIN members, and BASIX. No action was ever taken against these transgressors. We might ask why not? Perhaps, one might speculate, the CEOs and Chairmen were all making so much money from the poor that they wanted the music to keep playing and the dancing to go on a little longer?

Finally, you quote from Mr Mahajan about his ‘concern. This is an interesting quote but it is simply talk, nothing more. The actions by BASIX as one of the ‘big six’ say it all: BASIX very much helped drive the over-indebtedness, plus Mr Mahajan’s blanket refusal to do anything to halt the unsustainable growth trajectory while at MFIN, surely show that that talk was pretty meaningless.

Massive financial malpractice and unethical behaviour by Wall Street and its sidekick, the City of London, led directly to the global recession we are in today. Our financial watchdogs failed to put a stop to their antics, but some academics helped them by misrepresenting and glossing over what the financial titans were doing. We all saw 'Inside Job'. We should not do the same thing with regard to the poor and India and the horrendous antics of the microfinance sector in Andhra Pradesh, which very much includes BASIX. I think INSEAD students, as well as the wider academic community, deserve better than this.



Arunachalam,

Hi, I have concrete proof that BASIX was one of the MFIs that turbo charged the Indian growth story that led to the 2010 AP crisis. See my blog posts on moneylife and I am happy to send you copies of my books which carry all evidences in black and white. Send me your address pls and will send you the books - An Idea Which Went Wrong and The Journey of Indian microfinance and they carry enough concrete information on BASIX as well as other MFIs. I even have video tapes of clients talking and there are so many issues with BASIX, - look at what Sajeev Vishwanath former CEO of BASIX said in his quote to ET in Nov 2010, look at APMAS report which shows many clients of BASIX with multiple lending, Look at the analysis of the BASIX code of conduct reports on moneylife/my blog, Look at MFIN's structure and people (like Mr Ajay Verma) when Mr Vijay Mahajan was Chair. I also have proof of data manipulation with regard to data of BASIX at MIX market (who did it, I have no idea!). So let us set the record straight - BASIX was one of the 6 MFIS which engaged in UNDESIRABLE practices and led to the huge growth of Microfinance in AP. Pls refer http://www.moneylife.in/author/ramesh-s-arunachalam.html and http://microfinance-in-india.blogspot.in/2010/11/analysis-of-apmas-april-2010-study-on.html (just an example and there are many articles), http://www.moneylife.in/article/what-is-said-at-conferences-is-very-different-from-what-is-implemented-in-practice/22124.html, http://articles.economictimes.indiatimes.com/2010-11-11/news/27577103_1_sks-microfinance-mfis-shgs and I can give many more). The idea is not to isolate BASIX but point out the truth and fact that they were equally responsible for the AP 2010 crisis! Thanks and have a good day!

Hugh Sinclair,

"Microfinance is an essential part of the equation for the eradication of poverty. Without microfinance, many poor people have to turn to moneylenders who charge usurious levels of interest..."

I think there is little point drilling the author of this paper on Indian microfinance until he has read Ramesh's book (which I have, it is great). This article is a classic "desktop" academic piece with limited experience of the sector. The quote above reveals everything. Firstly, microfinance is essential for the eradication of poverty - but no evidence is cited, as Professor Bateman points out. The "poverty eradication myth" has been so thoroughly debunked nowadays that it is hardly worth examining. Even those in the sector increasingly concede this point.

But actually this is not the main flaw in this comment. Could the author define usurious rates? Usury is a term often used in such conversations, but rarely defined. This is an article written by a rigorous academic - please define the term. At what APR does an interest rate become usurious? It's a simple question, but how else can we compare the evil moneylender (the boogeyman of microfinance fanatics) with the life-saving benefactors (the MFIs)? Give us a number, or a range. Plus, bear in mind that moneylenders are often a lot more flexible than rigid banks, but that's a detail. Keeping usury un-defined enables the sector to blame the mythical moneylender without falling prey to the same accusation. The author suggests 35% is "high", but presumably not usury. So, what is usury?

The author then suggests that microfinance institutions have replaced the moneylender with a greater "force for good". So, we are to believe that the $11 billion currently lent to the 30 million Peruvians would otherwise have been lent by the moneylenders? That's quite a few moneylenders. There are presumably a lot of them currently unemployed. I wonder what happened to all their money? And this is not to mention the rather awkward fact that in Peru the #1 MFI, MiBanco, collapsed recently, and was flogged in a firesale to a competitor.

The fundamental problem with articles such as this is that their apparent wisdom originates from an ideological desire to believe in the power of microfinance, and this is hardly surprising originating from INSEAD. We need to believe in free markets, teach a man to fish, power at the bottom of the pyramid, social enterprises, competitive forces delivering beneficial results, or the "capitalist principles" the author mentions. We can concede the occasional market failure, but these are mere hiccups along the way. It doesn't occur to such believers that the entire model may be flawed. Look at the examples cited in the paper: the classic farmer buying a tool, from which he will work his way out of poverty and repay the loans to rescue yet another farmer. But the farmers compete with one another, margins are driven down, and besides, most don't buy a tool but consume the loan within days, and are then saddled with the loan, which they invariable refinance with a loan from another bank, and so the game continues, with the first mover MFIs making vast profits, and the sectors eventually collapsing. Thus Bosnia, Morocco, Nicaragua, Andhra Pradesh etc. etc.

My favourite was when Kiva showed the video of Pedro, the squat moustached Bolivian coffee farmer who gets a loan to buy a tractor when his cow dies and he can no longer plough his land. With the tractor he can grow ten times more coffee. Dr. Mader points out that coffee farmers do not use cows or tractors to plough fields, coffee is a shrub, and no amount of tractors can increase yields by 10x. But the key point is that the underlying facts do not matter - institutions like Kiva sell a dream, an ideology, a myth, and people like hearing this, and open their wallets.

What is undoubtedly true is that microfinance can be extremely profitable for a few lucky individuals, and they can do so under the praise of naive students and business school teachers enamoured with the concept of "social enterprises". Does it work? Does it even make sense? These are details.

In addition to Ramesh's excellent book on Indian microfinance, Mr. Chattopadhyay might wish to read Black's book on control fraud, "The best way to rob a bank is to own one".

http://governancexborders.com/2013/12/10/kivanomics-101-or-dkyc/
http://monthofmicrofinance.org/engage/blog/the-mystical-lure-of-microfinance/

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