Access to Finance for Financiers

dKXGkaWhile enough literature is available pointing out to the lucrative business (and impact) that local financial institutions could target by reaching out to the micro and small businesses in any economy, there is very little written about how these “local financial institutions” can access funding to re-lend to this segment underserved segment. By nature, small businesses are risky and lack of formally verifiable income makes it difficult for banks to lend to small business. To some extent, it is right that banks avoid getting into financing risky business at a large scale given that they risk putting retail deposits at risk in case they build a very risky loan book. This means that there is clearly a need to address the credit needs of smaller enterprises through a network of more nimble financial institutions. In fact, in India some specialised lenders have come up over the years catering to different types of small businesses. Such financial institutions are recognised by the Reserve Bank of India as well.

They reach out to the “lucrative” MSME segment through customised appraisal mechanisms and lending processes and often due to their close ground presence manage to have a fairly good quality of loan book. Higher risk is adequately compensated by higher yield AND additional measures like closer monitoring prevents high default rates. This makes it look like an attractive proposition for people who want to invest (as debt or equity) in such businesses. In fact, a lot of these business have got significant equity interest. And that is where it starts to get interesting.

They have an interesting problem of being able to raise equity while not being able to raise enough domestic debt. A clearer inspection would reveal that the equity raises have largely been from foreign sources and often result in companies facing hurdles around the guidelines that guide loss of shareholding vs FDI amounts invested.

While the debt could have also come in from offshore sources, bringing debt into India from foreign jurisdictions faces lot of obstacles in terms of process (which has become significantly smoother over the years but it still continues to be a pain). These small financial institutions depend largely upon banks for debt funding and banks in India don’t fund anything unless the borrower is large enough or unless they the borrower is classified as priority sector. If a corporate entity doesn’t fall into any of those categories, their growth expectations are doomed because banks just wouldn’t fund.

Of course, banks have their own reasons. Most of these small financial institutions would be less than investment  grade (as per rating agencies) or just about investment grade. “Risking” money in something that the rating agencies don’t call investment grade is criminal in a bank setup.What banks miss though is that there is a way to assess such companies by moving out of the branches and observing the operations of those companies, their people and their practices. A small group of debt funding companies (companies that I have worked for most of my career) understand that and provide funding to such small financial institutions based on strong/relevant evaluation practices. In my experience of working with such companies and debt funding of more than INR 9000 Crores, there has not been a single case of non performing assets, be it in the form of on balance sheet loans or in the form of off balance sheet transactions.

Beyond banks, we also have other sophisticated financial institutional investors who can measure and establish appropriate risk mitigation strategies but even they don’t because the size of funding that each individual small financial institution seeks is not economically interesting. Honest and successful efforts have been made by the organisations that I have worked with to bring larger investors to fund these smaller financial institutions but it still takes a lot of push to make such transactions happen. It is not the norm.

As a result, the growth of new small financial institutions which have the ability to cater to smaller enterprises and customers, enabling financial access for all have been very slow, painfully slow. Entrepreneur interest in setting up new financial institutions to reach out to smaller enterprises and households have waned in spite of all data/reports and literature suggesting that there is a large market to be addressed. The number of new NBFCs coming up in the Indian market have slowed down in the last 2-3 years. The only ones who continue to move ahead are the ones with significantly large equity backing. Crossing the Chasm before success is dependent entirely on equity.

A portfolio size of INR 100 Crores in portfolio outstanding seemed to be like something that could garner interest of banks. Such a portfolio size could also give rating agencies enough track record to consider a rating upgrade. It seems that the number is of INR 100 Crore in portfolio size is becoming less important now. It is more important to know how much of that INR 100 Crore is funding with equity because more often than not, debt wouldn’t be easy to get for such companies anyways.

In other words, bootstrapping as a strategy to enable access to finance for SMEs in India is a very challenging job! So, banks won’t fund small enterprises because they are small and risky and no body would fund those who can fund small enterprises because they are not large and not priority sector. How do we then make it easier for small enterprise to access debt in India?

Photo Courtesy: rgbfreestock

Also published on LinkedIn.

Enterprise and Quest towards reducing friction

Customer loyalty is a result of reduced friction.

All successful enterprises (for profit or non-profit) are in the business of reducing friction that a customer faces in the process of accessing  products or services required by the customer.

Friction, that arises during pre-product acquisition as well as post product acquisition phases, needs to be reduced to build customer loyalty. Successful enterprises strive to reduce friction during both phases.The expectation is that reduced friction in accessing a product or service will encourage the customer to be more willing to use only that specific enterprise as a source/channel, i.e. customer loyalty.

However, friction doesn’t get reduced in one go because it is not just the customer experience but also the customer mindset that is in play behind the decision of a customer to be loyal to an enterprise.

From a customer perspective, the willingness to use a particular channel/source follows a four step process as shown in the diagram below and in some ways, each specific sector/industry has evolved over the years following these steps. As an industry matured, successful enterprises within the industry had to take a step upwards to remain in the fray. Those that could not, fizzled out.


Steps towards low friction.

The first step is continuity i.e. being available “forever”. A customer will not invest time and effort to understand how the channel enables him to access the product or service unless the customer is certain that the channel will continue to be available for a significant period in future. Eg: Continuity is a feature of public sector undertakings and is often a default choice for many people.

Predictability is the next level. Predictability is the certainty the enterprise will be able to provide you with the service/product at an expected point of time or as per an expected schedule. Predictability is also the certainty that the product or service will have a set of basic characteristics that the customer expects. Eg: If you require to pick up a coffee at a local store everyday on the way to office and you realise that it is not certain whether it will stay open, would you depend upon it or look for an alternative before that?

Continuity and Predictability together build a sense of Reliability in the customers’ mind.

The next step  is convenience i.e. being available at a point of time, in a form and at a place that meets the customers’ requirement to the best possible extent. An enterprise can meet all three requirements or aim to achieve at least one of the above to be considered a convenient channel. Eg: gets you groceries at your place, at an expected time slot and the products are generally fresh! Many who have started using it, often don’t give up.

Beyond convenience is the flexibility offered by an enterprise. Flexibility in terms of product/ service options that meet specific needs of each individual customer and/or the ability to modify the choice during the process. Eg: Flipkart lets you return without any questions asked!

Convenience and flexibility are bring about a sense of Ease of Access in the mind of the customer which builds stickiness or customer loyalty.

Reliability and Ease of Access need different approaches.

Interesting thing about the aspects of Reliability and the Aspect of Ease of Access is that the ability to rely varies widely with the mindset of the customer (within the same customer profile) but the ability to perceive ease of access is quite democratic within a similar customer profile.

All new enterprises need to identify a set of early adopters who have the mindset to rely upon the enterprise more easily than the majority population. If the early adopters are satisfied, the word of mouth will enable the late adopters to start believing in the enterprise ability and move over. While it is difficult for the late adopters to easily rely, once a late adopter joins, it is not very difficult for the late adopter to see the value of Ease of Access.

In fact, ease of access is something that is often the most visible aspect and often a part of the sales pitch of the enterprise. Reality is, the customer needs to cover the first two steps before they can get the benefit of ease of access and the first two steps is more about the customers’ mindset that what the product offers.

So, while it takes a lot of effort to build a perception of reliability, a perception around ease of access is built easily. Similarly, it is easier to change perception with regards to ease of access than with regards to reliability.

It must be noted that Reliability is fundamental to the success of the enterprise. An enterprise can fight it out if it is reliable but doesn’t offer ease of access. However, it is impossible for an enterprise to survive if it offers ease of access but doesn’t offer reliability.

How does an enterprise provide Reliable and Easy to Access products/services?

As an industry matures and more enterprises join the fray, management of the issues that help in building the first two steps get fairly commoditised i.e. earlier, services/products that met the basic first two steps used to have economic value and used to be distinguishable but with more competition, they end up losing differentiation and hence lose the ability to build customer loyalty. The result is that in addition to Reliability, Ease of access becomes critical to the ability of the enterprise to command margins and survive in a mature (competitive) market.

Co-ordination (between different supply chain actors) or innovation (technology or process)enables the enterprise to provide better ease of access. The ability of the enterprise to work on these two aspects while keeping the customer shielded from the brisk activity in the back-end by providing an interface that cancels out all the noise (of co-ordination/innovation) is what reduces friction and builds customer loyalty.

Models of Charity

On a different planet called Vrithpi, two models of welfare for lower income Households (HH) were observed. Govt Led and Private Sector led. Which of the two (explained below) do you think is better? (The currency on that planet is called Rx)

Model 1 (Govt): In some rural locations, under the ONREGA scheme of the Govt low income people get paid Rx 120 for a day’s work and they get subsidised food that costs you Rx 20 a day under a group of some other Govt schemes. So, people work for a day and take rest for 5 days and then seek work again.
The govt raises debt from the market through govt securities to fund the payments. To repay the debt, the Govt taxes the salaried people and charges a cess on those who spend, for consumption of services or products. So, the honest tax payer loses money to feed the lower income HHs.

Model 2 (Private): In Bhaiderabad of Vrithpi, Zola Travels pays each auto  rickshaw driver (I am sure they have similar schemes for cab drivers) Rx 30 for each ride in addition to the metered fare that the rider pays, which is generally Rx 10 more than the meter. Zola also pay Rx 50 per day if they make three Zola trips during the day. So, the low income earner auto rickshaw driver, works only for Zola trips and let go of other trips unless the riders offer atleast Rs 40 more than the meter (which is often already tampered with).
To fund the Rx 30 and 50 Zola raises equity from fat pocketed Private Equity (PE) investors and sells them the story of long term market share and benefits of short term losses for long term windfall gains. But windfalls are rare. NAmazon sold the same story to public when they got listed 15 years ago and they still dont make money. So, the filthy rich PE guys lose money to feed the lower income HHs.

While both lead to market distortions and lower productivity, Zola Travel reduces income inequality in a very novel way by taking money away from the filthy rich. But what does the Govt do? It takes the wind out of the sails of only the salaried. So, which is a better model of welfare?

Oh wait, somebody very rightly pointed out that these PE guys don’t just “invest” the money of the filthy rich. They actually do get funded by large pension funds who who get money from salaried individuals (again!) and that money is meant to be the cushion when, due to old age, the ability to earn recedes.

What do they smoke in Vrithpi?

[Please Note: Any resemblance with anyone living or dead on Earth is unintended and a co-incidence. These models are not seen on Earth.]

MUDRA Bank – How will it help?

First things first, a regulator cum re-financier (market player)  is bad design. Period. It leads to moral hazard where the regulator will shape policy to grow only its business. Yes, refinance is business.

But I hear that MUDRA Bank is expected to be a regulator and financier of microfinance institutions and micro-enterprises. Why?

The only other entity with such an entitlement, the National Housing Bank (which is a regulator and refinancier for Housing finance companies and bank housing loans) is expected to lose that status once the long pending NHB Bill is passed in its current form. The bill aims to move the regulatory powers of the NHB to the RBI and let NHB continue to operate as a sector focussed bank like NABARD and SIDBI. Obviously, the law makers realised that regulation and business do not go hand in hand.

That brings me to the second question, NABARD refinances MFIs, so does SIDBI. SIDBI refinances/ guarantees small/micro enterprise finance. So, basically, between the two they pretty much already do what the MUDRA Bank is supposed to do on the refinance side. So, why do we need a MUDRA Bank?  Yes, they don’t regulate. So, to regulate?

When the microfinance crisis broke out, there were discussions of NABARD being made a regulator for the MFI industry but that did not happen, primarily due to the fact that NABARD was actually a refinancier (a service provider) for MFIs and the significant majority wanted NABARD to continue as a service provider and not become a regulator in parts due to the lack of infrastructure and in parts to avoid the moral hazard issue. The only reason why NABARD was brought into the picture was microfinance institutions not only included the RBI regulated NBFC-MFIs but also societies and trusts not regulated by he RBI.  However, NABARD felt that they did not have some of the “missing links to operate in the sector” as a regulator.

What then, will the MUDRA Bank do differently? If the several decade old and experienced NABARD thinks they can’t handle the job, how will the MUDRA Bank manage?

Another interesting proposed change is that the FMC and SEBI are going to be merged, the logic seems to be that financial and commodity markets are, at the end of the day,markets and hence they should have a common regulator because this will streamline decision making and potentially trigger new products. Great!

And there comes my third question, why then are we trying to create multiple entities for microfinance and enterprise finance? Where is the coherence in “strategy”?

Instead of seeding new ideas, would it not be better to energise the NABARD and SIDBI to take the word “Development” in their names seriously for their respective sectors? To adopt innovation and  shake away  some of the bureaucracy that binds them down? To adopt proactive measures to tackle the problem of access to finance for small businesses?

And please, for the sake of humanity, why should a bank promoting entrepreneurship favour only the scheduled castes and tribes? Favour all enterpreneurs, if you can. Nobody does that in our country.

(Edited on 9th March, 2015 to add an article on the same topic by noted journalist/author Mr. Tamal Bandyopadhyay. He seems to point out similar concerns.)

Money comes full circle (?)

(Ramblings below. Just thinking out aloud. Any guidance helpful.)

Currency evolved as a means of exchange of value, an improvement over the barter system. The barter system was in itself an exchange of value but it was not standardised and secondly, because the items exchanged varied from people to people, the barter system did not have the ability to duplicate/compare the value in two separate transactions. It could not “store” value  beyond one transaction. If you duplicated the same transaction in another situation with another set of people it may/may not have the same worth or value. It was each specific transactions that decided the worth of the exchange. The value of a transaction changed with the type of item exchanged and with the demand and supply situation of that item exchanged.

Commodity based currencies were the first to evolve, I guess, gold drops, silver coins, bronze coins. All created by nature and shaped into some form by men and introduced into transactions by a royal order. Standardisation arrived. Now, instead of the individuals deciding the worth of the exchange, the royal authority did.

Then came Central Banks and paper currency backed by gold, silver, etc. Now, instead of a small local kingdom, the value of a transaction was set decided by a Government. It created currency and assigned values based on gold stock available.Then the currency was de-linked from gold.

The Government or Central Bank now controlled the circulation and creation of more currency and hence had complete control over the value assigned to the currency.

With BitCoins, the creation of currency is decentralised to individuals instead of Central Banks or Governments. BitCoins interestingly do not represent a currency but a transaction . The worth of  a specific transaction is decided by individuals in that specific transaction. Its value goes up and down with the demand/supply. Is BitCoin a standardised Barter System with a central register where all transactions are authorised?

Whose responsibility is it to make one “job-ready”?

The industry cribs all the time that Indian education doesn’t produce enough job-ready people. I wonder, is it the responsibility of the schools/colleges to make one job ready by training them on specific tasks? Or is it the school/college’s responsibility to provide the students with the general tools and knowledge of theories and practices that will help when they take up a job. No school/college ever knows what job each of its students will take up. So, it is not possible to train the students on specific tasks! It is fair that they impart training that is general in nature. And, it is obvious that such general training may not be useful for specific employers.

The employers have all the specific processes and equipments that can be used for demonstration and making the new entrant job-ready for that specific job. Only employers can provide this customised training required to make the best job fit. So,  shouldn’t the employers be training them? Are the employers shirking responsibilities? Do all the employers in our country today have customised training for their new recruits/staff?

Standard Reply: The employers fear that whoever they train will soon escape to some other employer and so they don’t want to invest. Really? So, the alternate solution is you crib and take in half trained people and use them immediately to deliver services and products which are equally half baked?

Is trainee/apprenticeship period for training new recruits and making them job ready? Or is it a few months when the new recruit is like any other experienced employee, expected to deliver but at a lower cost and with the flexibility to be fired at short notice?

(Views of an outsider who is very much a part of the story.)


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