Microfinance is the business of providing very small loans, or "microloans", to poor communities around the world in an effort to spur local entrepreneurship and community development. With most loans valued at less than $100, this is oftentimes all that is needed to jumpstart economic growth in impoverished areas. Given the World Bank estimates of 1.2 billion people living on less than $1/day, a collateral-free loan of $100 is a pot of gold to a large chunk of the global population. And with an estimated 50% of the population living in communities with no financial services, having a three billion person (or $300 billion) target market translates into quite an extensive market opportunity.
Photo:Diva Eva, Creative Commons, Flickr
One of the major challenges that the microfinance industry is facing right now is how to raise $300 billion to reach the required geographies. So far, only a fraction of that total has been raised, largely because most microfinance instituions are NGOs. So, one would think that this is a space that could definitely use some government help. It only makes sense that, as the leaders of the free world, the U.S. government should step in and bridge the gap required to raise the world out of poverty, right?
Wrong. The U.S. government already does provide billions of dollars in foreign aid and its effectiveness can be debated. And aside from the fact that our government is already too busy throwing billions of dollars per month into a black hole called the Iraq War, this is an industry that can be run 100% by the private sector, without a single dollar of government subsidy. In fact, it's happening as you're reading this article.
Last week, I attended a presentation given by Vikram Akula, the founder and CEO of SKS Microfinance. Launched in 1998, SKS has since provided loans to over 700,000 clients in India and aspires to increase that number to five million by 2010. SKS has acheived an over 98% on-time repayment rate. And, unlike its NGO competitors, SKS is a for-profit organization that operates on a for-profit business model. This allows the company greater access to the much-needed large pool of commercial capital that can be deployed in this space.
Once it was shown that microfinance can be an economically viable business opportunity, private funding began to pour in. SKS has attracted brand-name lenders such as ABN AMRO (ABN), Citigroup (C), and HSBC (HBC), and equity investors such as Vinod Khosla and Sequoia Capital. The sell side is starting to look into raising financing for microfinance institution as well, evidenced by the recent funding of MicroVest by Morgan Stanley (MS) and Lehman Brothers (LEH).
A question from the audience was raised about what kind of interest rates are currently being charged by SKS for this kind of service. The answer was surprisingly large — north of 20%. Given that SKS esssentially has a monopoly on India right now, this should come down as more competitors enter the marketplace. With a $300 billion target market, the market potential for microfinance is stunning. SKS has thought ahead of the curve, but it will be interesting to see how new competitors entering the business will differentiate themsleves.
In a vein similar to various articles we have previously posted about sustainaibility in the workplace, microfinance is gaining momentum simply by being the "right thing to do". Microfinance institutions have multiplier effects that direct government subsidies do not address. Perhaps this may lead to money saved from the U.S. government's coffers in the future that would otherwise be spent on direct foreign aid. The private sector is starting to embrace microfinance because it serves a worthy cause and can be quite profitable to do.
Disclosure: I do not own any of the aforementioned stocks but I will strongly consider owning SKS if and when it goes public.