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.)

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.

Reading List- 23rd Nov, 2013

1.)What if your memory is fake?

Article: Fake memory

Those people who seem to have a photographic memory might just be having a fake memory!

2.) A brilliant innovation gets you fit for the Olympics!

Video: Subway tickets

3.) The story of Mike Tyson. Told again.

Article: Mike Tyson

4.) How Amazon became an everything store

Article: Amazon

5.) Why does airline food suck?

Article: Airline food

Boredom and Low humidity are two key reasons along with constraints in preparing food in the air. We lose sense of taste/flavour due to a blocked sinus and low humidity. This makes us less perceptive of the taste. Interestingly, Indian food is less affected by these conditions due to the fact that naturally permits humid sauces in its preparation.

Pricing: Loan against property v/s home loan

Simplified Definitions

Mortgage Loan/Loan Against Property (LAP):A mortgage loan is given for an open end use and is given against the lien of a property.

Home Loan: is given for a restricted purpose of buying/ constructing a house to stay.

Typically a mortgage loan is often the most common way of raising funds for growing the business. Banks typically get comfort from the availability of fixed collateral to be able to recover from in case of loan default.

The rate of interest charged on a Loan Against Property is higher (much higher) than a Home Loan.

Historically, default rates of LAP (for business purposes) have been high justifying a high rate of interest.

Why?

Question 1: Is the assessment of loan eligibility for LAP done assuming that cash flows from the business will grow due to utilisation of the funded amount for capex/WC use? If that is not the case, why would the default happen?

Question 1 a.) why can’t we give the loan based on existing cash flows?

People say that the loan size would be too small and not meet the requirement for the capex. My comment on that response would be “Oh common! let’s grow step by step. Give me some other reason”.

Question 2: Why doesn’t the “emotional attachment” story that works in case of home loan doesn’t work for LAP?

Question 2. a.) Does the person seeking a LAP have multiple properties and so property offered on mortgage has lesser “Emotional attachment”?

Guess so.

(Also, the question is how enforceable is the mortgage? In a lot of cases, especially developing countries, legal recourse may just be too cumbersome/ inefficient. So, isn’t the collateral acting more as a deterrent. I guess it is.)

Question 3: Would a LAP given based on existing cash flows AND after taking the owners current residential home as collateral completely change the loan performance?

That is what a number of financial institutions are now trying out with the lower income/informal sector entrepreneurs. Assess loan eligibility based on current cash flows and take the residential property of the entrepreneur as collateral. However, the interest rates continue to be higher going with the notion that LAP has generally resulted in high defaults. Interestingly, last 3 year’s history in these kind of loans show very low (between 0.5- 1 % delinquency in the 90 days past due bucket). Off course, three years is not enough time but these 3 years have been the roughest phase for business in India in general as well. The other key reason for good portfolio performance could be that this type of lending is new and the good quality selection could be due to the initial “start-up precautions” taken by the financial institutions starting this product.

Assuming loan performance does show improvement in this kind of loans, is there a reason to suggest lower interest rates and hence greater affordability?

At last but very important, one oft stated reason for low home loan interest rates is that the purchase of home does not generate additional revenue but LAP for small business does and hence the borrower can pay a premium. For all practical purposes, this reasoning silences all the discussion and the confusion around the pricing by simply stating that the lender wants his pound of flesh! That’s all!

What do you think?

How much equity and when?

When you judge a promoter on his interest in the business in terms of equity contribution brought into the business, what would you consider more sensible?

A. bringing in equity capital in phases

All start-ups are prone to initial setbacks but some of them can recover if further capital is pumped in to the changed business model (pivot). If the promoter spends all his money in the first attempt/business model, he would never have money to implement the pivot.

B. Bringing in equity capital in one go right at the beginning

If the promoter has brought in all his money into the business right at the beginning, it shows his dedication and indicates that come what may, he will make his business work.

From an investor perspective:

  • How do you determine which level of capital brought in is enough to prove seriousness of the promoter in the business?
  • Would the amount of personal equity brought in, indicating dedication to the business, vary from industry to industry? (My sense is yes. Tell me if I am wrong)

How would the assessment vary between the first equity investor and the first debt “investor”?

Beyond the Margin: Redirecting Asia’s Capitalism

On August 24, 2011 Avantage Ventures released a report titledBeyond the Margin: Redirecting Asia’s Capitalismthe first to analyse the Asian social finance market.

I had the opportunity share some of my insight thoughts with the Avantage Ventures staff during the preparation of this report. The report has, for the first time, made an attempt to give a number to the estimated size of the Asian Social Investments market. The report highlights six key social sectors that would benefit most from impact investments, these include:

  • Affordable housing
  • Sustainable agriculture and agribusiness
  • Water and sanitation facilities
  • Primary and special needs education
  • Rural and elderly healthcare
  • Rural access to energy

Of these, affordable housing, primary education and rural and elderly healthcare represent the three sectors with the greatest market opportunity. The report also estimates the potential market size that can be captured through impact investing in Developing Asia to be between USD52 to USD158 billion by 2020.

The report Beyond the Margin  can be found here. or here av_report_final_full_screen_version

Early stage investment in a start-up

A bunch of articles that talk about seed stage/pre-VC stage investments in startups. The debate is primarily between whether to do a convertible debt or to do a preferred equity. There are arguments both for and against each side.

The basic premise: convertible debt delays the conversation on valuation to the next round. It gives you the time to “set” the benchmark for your company’s valuation. Preferred equity is a simpler way of dealing with investments, if you are sure that your performances now gets you a fair valuation.

Brad Feld lays out the difference between convertible debt and preferred equity and points out that both routes have support. However, he does point out that if you do not intend to raise a big VC round next and hope to continue with small angel rounds, it is more sensible for you to do a preferred equity to be fair to your investors: http://www.feld.com/wp/archives/2006/02/whats-the-best-structure-for-a-pre-vc-investment.html

Josh Kopleman has a clear favourite in preferred equity because it aligns both the investor and entrepreneurs interest i.e. both with be interested in increasing the valuation of the company in the next round! However, he also says that a convertible note could be useful when you are already expecting a round of equity in a few weeks/months. He does give a few other reasons, read on… http://redeye.firstround.com/2006/04/bridge_loans_vs_1.html

Just in case you are suddenly confused about what Preferred stock is, here is a primer from the good old Investopedia to help you. Just go through the basics and come back for the remaining interesting stuff. http://www.investopedia.com/articles/stocks/06/preferredstock.asp#axzz1STNUO900

Seth Levine talks about the two options and clearly spells out the fact that though this seems to have a near term benefits for the startups he is not sure if it is sustainable in the long term. Great explanation of the context! http://www.sethlevine.com/wp/2010/08/has-convertible-debt-won-and-if-it-has-is-that-a-good-thing

Mark Suster clearly believes that convertible debt without cap is not here to stay for long. A nice write-up on how convertible debts came about and how the entrepreneurs should look at the option of convertible debt. http://www.bothsidesofthetable.com/2010/08/30/is-convertible-debt-preferable-to-equity/

Ok, the verdict is clear in the post title, Furqaan Nazeeri lists out reasons why he thinks convertible debt “sucks”. http://altgate.typepad.com/blog/2008/06/5-reasons-conve.html

Bill Payne explains the mechanics of convertible debt.  The graphs are missing but worth a read. http://www.matr.net/article-29148.html

A list of articles by Bill Payne on convertible debt and preferred stock. Great stuff in one place. http://billpayne.com/category/convertible-debt