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.

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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.

snowflake

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: Bigbasket.com 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.

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.)

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.)

Will the on-demand economy lead to skewed availability of essential services?

a little bit ofOn- demand economy businesses (like say über, Elance, etc) do the great thing of connecting idle resources with those who need them, whenever they need them and all of this at a reduced or nil search cost.  So, on-demand economy platforms/marketplaces enable better utilisation of resources and improve overall efficiencies.

While most people normally prize certainty of income more than “freedom” from fixed long-term contract, there are some who do not want to be tied up in a fixed long-term contract. They prefer to take up a short-term engagement to provide their services as per the opportunity given to them by the on-demand business platform and continue to earn without having to bother getting the fixed long-term contract. Unfortunately, such elite groups are few in this planet and are usually comprised of people whose basic needs are already met from some other source. Such people stand to gain from the on-demand economy as well.

This means that the on-demand business model essentially leverages the marginal cost concept to make service available on a marginal cost basis instead of the marginal plus fixed cost that a user would typically incur when taking services from a service provider organisation that employs people under long term  contracts to provide the services. So, not  unusually, the services provided by on-demand service providers is often cheaper.

However, the benefit of the on-demand economy is when an “idle” resource is utilized. Meaning that, somebody who is otherwise employed with a full time employer (an employer that pays for his employee benefits and social security) is interested in offering his services in his free time to earn additional money to support his needs. The additional earning is expected to satisfy only incremental needs because basic needs and social security are already taken care of by the full time employer. Hence, he is able to offer his services at a cheaper cost than what his normal hourly rate would be with his employer.

Now, if this on-demand business platform works efficiently, his employer, who is currently paying for his social security as well as his marginal cost of services, might wonder if they should cut costs and take the services of somebody from the on demand business platform at a lower cost where the employer will just be paying for the services and not be paying for the social security.

Imagine a world where all employers or all people who need services think that  on-demand is cheaper and more efficient and hence they should all go the on demand way for all types of services.

Two situations can arise because of everybody moving to on-demand service platforms for getting things done:

Situation 1: Since there is nobody to pay their social security, the on-demand service providers will hike their charges per service to meet their social security needs and since they are now not sure of getting the next order/request for service, they will charge an additional premium to safeguard themselves. Which means the cost of each service will go up and the people who were earlier able to afford the on-demand service because it was cheap are now unable to get the service. Moreover since, everybody has moved on to provide on-demand service, there is nobody who can provide service even at the earlier affordable cost provided by the full time employers. Only the rich few can now afford a service which was affordable to many.

Situation 2: The competition keeps on increasing and on-demand service providers are unable to hike their charges because there is always more people ready to offer their services than there is demand. Hence, nobody pays for their social security.

Both situations are extreme and dangerous. But, both situations are possible in pockets depending upon local market conditions. The world is not perfect, it has a knack of amplifying the negatives in any good thing and so it will amplify the negatives in the on-demand model as well. Till we have a perfect world (!), we need to take caution to avoid the situations mentioned above but let us not stop walking. We need to appreciate the shortcomings of on-demand from the perspective of a more balanced world and take appropriate measures. Is the Govt listening?

On-demand economy businesses is great thing but we must find a way to avoid a situation where the entire world/ or a majority shifts to on-demand ways. We will then have a world full of informally employed where income is never guaranteed but is highly variable. Not everybody can handle the variability. Not every situation (say illness) a person faces can withstand the variability and that is why we value certainty of a job more than informal income. That is why we value full time employment more than contractual labour. That is why we value affordability of basic services.

Fact is,  on-demand services are a stylised version of contractual labour which has seen its share of criticisms because of the uncertainty that it brings to the lives of those who provide services and the lack of responsibility that it lets organisations live with. It creates a dis-balance in the garb of increased efficiency.  Contractual labour had negatively affected the lives of those providing the services. Unrestrained growth of On-demand in its current form threatens to affect both service providers and the customers of the service, unless a counterbalancing innovation/policy is found.

Payments in remote locations

Payments to dairy farmers in residing in rural remote locations is made primarily in cash across India. Every week/fortnight, the milk collection van brings in a cash box and pays the farmers the price of milk bought since the last payday. In some cases, the payment is daily.

Experience revealed that in making payments to farmers through this route, the cashier handing over the cash often held back some amount of money as a “commission” or out of plain rowdyism. The cashier/ accountant would in a lot of cases be the favourite man of the secretary of the collection centre (society) or the secretary himself. The helpless farmer would then have to part with a fraction of the money due to him to make sure s/he doesn’t rub the powerful cashier the wrong way.

Some milk buying companies thought of a novel way of eliminating this problem. They started paying the money directly to the bank account of the farmer. The bank account was especially opened for this purpose. So, the cashier is no longer able to play foul. But, on every payday, the farmer has to abandon work (which means loss of a day’s wage or agriculture) and go to the bank branch which would be in a “nearby” town, some 15-20 kms away. He incurs travel expenses as well. The money has to be drawn out immediately because the farmer needs the cash to buy daily items like groceries, medicines, etc. There is no other source of cash income that is as regular/frequent as dairy. Moreover, much to the disgust of the bank manager in the town, there would be a long queue of dairy farmers waiting to draw their money on every payday leading to a tremendous rush in an otherwise quiet (and understaffed) bank branch.

The innovative milk buying companies understood this problem as well and figured out a solution. They handed over bio-metric cards to the dairy farmers for each bank account and got an “agent” tied to a third-party payments company to hand deliver the cash at the doorstep of the farmer. The agent carried bags of cash to the village and after bio-metric authentication hands the cash over to the farmer at the doorstep. But then, after a few months the agent starts charging commission, lesser than the cashier/secretary in the first situation but charges some amount. The bio-metric account reads that the farmer has drawn the entire amount of money. Though this agent works with a “private” company with greater accountability, the farmer agrees to let go of the amount because otherwise he will have to travel all the way to the bank.

We are back to square one and possibly in an even worse situation. In the earlier case, the cash was sent to the remote village in a milk truck with at least two persons on board. Not an ideal situation but it was better than what we see in this system. In this system, the “agent” typically hops on to a motorcycle with the bag of cash picked from a local bank branch and rides all the way to the villages. A few agents get robbed on the way. In fact carrying a few lakhs of cash does not turn out to be a safe thing to do. But there is no other way. Cash in transit insurance saves the day for some milk buying companies but some agents get killed.

Where does this end? “Mobile money” some people say. However, till the time the local grocery shops start accepting payments through mobile phones, how will mobile money transfer be of any use?

How have these risks been handled in India and outside? What are the examples of payments in remote locations seen in other parts of the world? What kind of supporting infrastructure is required to enable a safer payments situation?

(Also published on LinkedIn.)

Next…what?

 

Renewable Energy.

Water.

Medical Technologies. (Detection and treatment)

Agriculture.- Food production & Food preservation.

That is where breakthrough innovation is required. We will possibly see breakthrough innovations in these areas (in that order) in future. Something similar to what we have seen in case of communication technologies over the past decade.

While Renewable Energy and Medical Technologies have received venture investments, Agri-Tech and Water are still to see mainstream venture capital investments.