Deutsche Bank’s Investments in Micro-Finance Institutions (MFIs): In Tune With Its Own Global Micro-Finance Strategy?

Ramesh S Arunachalam

Folks, the last few weeks have indeed been a revelation on how investors operate in the international supply chain of micro-financing. Courtesy Hugh Sinclair and his controversial book, we have received a lot of insight into the functioning of MIVs and other investor(s) like Deutsche Bank.

In fact, commenting on Deutsche Bank’s Micro-Finance Investments, Hugh Sinclair notes[i]:

“Deutsche Bank has recently acquired 9.15% of the shares of Indian MFI SKS, which is a bank I question substantially in the book. It would be hard to defend any claim that Deutsche Bank were unaware of the claims about SKS given the adverse publicity the institution has received. Criticism involves the IPO process and personal enrichment of a few individuals and private investors; abusive debt-collection practices, leading to explicit mention in the SERP report regarding client suicides; and most recently, “massive problems” with their life insurance practices, amongst other criticisms. Deutsche presumably found such factors compatible with their ethical practices.

Therefore, I believe that there are genuine concerns about the role of Deutsche Bank in the battle to reduce poverty. I believe there are valid reasons to support the case that their due diligence is not as thorough as it could be. I believe there are fundamental contradictions between the claims made in the SMART Campaign (which Deutsche Bank endorse and support financially) and Deutsche Bank‘s subsequent actions. I believe that the MIVs are largely (not entirely) responsible for a significant part of the adverse activities of some of the less scrupulous MFIs globally, not simply in India, by providing fuel for the fire and turning convenient blind eyes when it suits them.

I also await a formal response from Deutsche Bank in this regard, and I would like to hear Asad Mahmood's defence of the claims made in this book, and his explanation of the recent SKS investment. I assumed they may be shaken into acting more ethically in response to the book, but in my personal opinion, the fact that they now invest in an institution such as SKS, and did so via a tax-efficient investing vehicle based in Mauritius, leads me to a personal conclusion:

There is little evidence of concern for the welfare of the poor; profit is the driving force (acquiring equity in SKS following a 90% fall in share price); and their actions are inconsistent either with the best wishes of the investors in their fund (assuming these wishes to be social impact rather than profit) or those of the poor. This is my personal opinion, others are free to disagree.”

What is increasingly convincing me that, what Hugh Sinclair has been saying may indeed be a “correct” representation of reality as far as investors like Deutsche Bank are concerned, is the recent investment by Deutsche Securities Mauritius Limited in SKS Micro-finance Ltd, India’s only listed micro-lender. The investment that I am referring to is the purchase of shares worth Rs. 779 Million (US[ii] $ 13.90 Million) by Deutsche Securities Mauritius Limited in SKS Microfinance. As the Bombay Stock Exchange (BSE) lists under “Disclosures under SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011”     (http://beta.bseindia.com/corporates/Sast.aspx?scripcd=533228), it is indeed true that Deutsche Securities Mauritius Ltd acquired (on 25^th July 2012) through a QIP allotment, 9.5 Million Shares in SKS Microfinance Limited. The original table from the BSE site is reproduced below.

And a Times of India article[iii] commenting on the above transaction, observes that:

“Interestingly, Deutsche Securities Mauritius held 3.82% stake (27,61,174 shares) upto March 2012 but had exited the company during the April-June 2012 quarter as per shareholding data available on BSE. Deutsche Securities re-entered India's only listed MFI player through the QIP that was offered at a price of Rs 75.4 per share, a discount to the then prevailing stock price. CLSA (Mauritius) Limited too has picked up 9.15% in SKS through the QIP and was allotted the stake last week. The QIP issue had opened on July 12 and closed on July 17, with SKS mopping up a total of Rs 230 crore through the Rs 165 crore QIP issue….SKS, which was once India's largest MFI player, has been strapped for cash after it was plunged into losses by the AP MFI crisis that was triggered in mid October 2010 by the Andhra Pradesh government clampdown on MFI lending after a string of borrower suicides rocked the state due to the alleged strong arm tactics of MFI agents.”

Now, what do we know about Deutsche Securities Mauritius Limited?

According to available secondary data in the internet[iv], Deutsche Securities Mauritius Limited, is incorporated in Mauritius with Registration No. INMUFD175508 valid up to 06 - JAN – 2014. According to other information available across the internet[v], Deutsche Securities Mauritius Limited is said to operate as a subsidiary of a Singapore based company called Deutsche Asia Pacific Holdings Pte Ltd.

Deutsche Asia Pacific Holdings Pte Ltd, as a company, is said to engage in financial futures, options broking, stock broking, foreign exchange trading, and provision of related financial advisory services. Deutsche Asia Pacific Holdings Pte Ltd is said to have been formerly known by the name – ‘Deutsche Morgan Grenfell Asia Pacific Holdings Pte Ltd’.

And going further up the ladder, we find that Deutsche Asia Pacific Holdings Pte Ltd is said to be operating as a subsidiary of DB Valoren S.à r.l which in turn is said to be a Luxembourg based company. And completing the circle, we find that DB Valoren S.à r.l. is said to operate as a subsidiary of Deutsche Bank AG. Please exhibit # 1 at the end of this article which shows this relationship to Deutsche Bank AG in a clear manner

Therefore, it is clear that the purchase of shares - of SKS Microfinance Limited - was done by one the key subsidiaries of Deutsche Bank AG. Therefore, this investment can certainty be called as an investment made by Deutsche Bank AG or the Deutsche Bank group.

Okay folks, what are the key issues concerning this investment made by Deutsche Bank?

Read the following news items and it will become clearer.

First, according to a recent news item in The Hindu Business Line article[vi] (May 22^nd, 2012) –

“’We have found massive problems in insurance operations of SKS Microfinance’, Mr J. Hari Narayan, Chairman, Insurance Regulatory and Development Authority, told Business Line. IRDA teams conducted field enquires and inspections for a long time, he said. The irregularities included receiving the cheques of death claims from its insurers on its name, which is illegal. The only listed MFI in the country, based out of Hyderabad, had also ‘collected’ higher commissions than permitted by the insurance regulator while selling the insurance policies”.

Second, according to a recent news item in Moneylife article[vii] (July 27^th, 2012) -

“SKS Microfinance has said that some of its employees have cheated the company to the tune of Rs15.8 crore in the last financial year, reports PTI. The services of employees involved have been terminated and the company has written off over Rs14 crore. The auditors of the company have reported that there was cash embezzlement by the employees to the tune of Rs2.5 crore and loans given to non-existent borrowers was Rs13.3 crore, the micro lender said in its annual report”

I am not sure that anyone would invest in a company that has been directly accused (of having massive problems in their insurance operations) by no less a person than the Chairman of a major regulatory authority covering insurance operations in India. And for the record, Mr. J. Hari Narayan, Chairman, Insurance Regulatory and Development Authority (IRDA), is a very well respected (professional) regulator. That apart, investing in a company that self-admits increasing ghost clients and frauds[viii] in its operations is again a very serious matter.

And coming on the back drop of the (now) famous LAPO (Nigeria) case – where Deutsch Bank’s Comminty Development Finance Group (CDFG) lent money to the MFI despite publicly available information with regard to illegal savings collection and intermediation by the same MFI and presence of several other serious weaknesses in the same MFI’s operations - Deutsche Bank’s micro-finance investments certainly need good explaining by their management.  This is because of the claims that Deutsche Bank makes with regard to micro-finance and micro-finance investments:

“Deutsche Bank was the first global bank to establish a socially motivated microfinance fund more than a decade ago. Our activities in the microfinance sector are led by the Community Development Finance Group as part of the Bank's overall Corporate Social Responsibility commitment. We provide loans, investments and limited philanthropic grants to the microfinance sector towards the goal of enabling the poor throughout the developing world to access credit for self-employment as a poverty alleviation strategy. We have served over 120 microfinance institutions (MFIs) in 50 countries over the last decade, with $215.5 million in capital benefitting as many as 2.8 million poor entrepreneurs. While India is one of the largest potential markets for microfinance, Deutsche Bank currently does not have any loans to microfinance institutions there due to the rapid commercialization of the sector and concerns with pricing of the loans to poor clients.

Deutsche Bank is not active in the microfinance sector as a commercial activity to realize financial gains for the bank. However, Deutsche Bank recognizes that the success of microfinance depends upon its ability to utilize business discipline and financial techniques to achieve the goal of scale and sustainability in serving the financial needs of the un-banked poor. Deutsche Bank has developed social scorecards through which it judges the social intentions and the extent of social framework of MFIs in its underwriting. Deutsche Bank's MFI clients must meet standards of good governance, transparency, and interest rates that are reasonable within the country and regional context.

Over the last decade, Deutsche Bank has been a consistent advocate and voice in emphasizing the essential social objectives of microfinance and has used its leadership position to call attention to the sector's growing risk of aggressive commercialization. Some examples of our advocacy efforts are:

a)   In early 2008, Deutsche Bank gathered industry leaders including CEOs of MFIs, academics, rating agencies, development banks, and thought leaders to discuss the challenges facing the microfinance industry with increased purely commercial investors entering the market. This roundtable discussion led to the Pocantico Declaration, which was an important historic moment in the history of microfinance, providing clarity of intentions and values for the sector in being committed to the interests of the poor.

b)  Following the Pocantico Declaration, Deutsche Bank was the early funder and one of the architects of the SMART Campaign, which focused on protecting the interests of microfinance clients by making sure that poor borrowers were not over-indebted, that there was transparency of pricing, that collection methods were not excessive, and that clients were treated fairly.

 c) In November, 2010 Deutsche Bank organized a roundtable and brainstorming session on the potential risk of multiple borrowing and over-indebtedness with in-country microfinance networks, development banks / agencies, and philanthropists.

d)  In partnership with Moody’s and leading universities such as NYU and Yale, Deutsche Bank initiated the idea and organized a large conference at its headquarters in America where a discussion of the social impact and innovation of microfinance took place. 

e)  In 2011, DB convened a meeting in New York with eight CEOs of the leading microfinance networks to discuss challenges with a view to forming an association that can collectively address issues faced by the Industry. The unprecedented meeting resulted in the formation of the Microfinance CEO Working Group comprised of industry leaders from ACCION, FINCA, and Pro Mujer, among others. Subsequently, the Group released a report “Road Map for the Microfinance Industry: Focusing on Responsible and Client-Centered Microfinance” which addresses responsibility and development of client services and products.

With more than half of the world’s population living on less than two dollars a day, there is an urgent need to alleviate poverty. Microfinance is a business approach to helping the poor build their way out of poverty, by providing the poor access to financial services, namely credit and a safe place for their savings. Microcredit, the extension of very small loans (microloans) to poor and low-income entrepreneurs who cannot access local traditional funding due to a lack of collateral, or a credit history, has proven to be a revolutionary model for enabling the poor to rise from poverty.

With capital to grow their businesses and increase earnings, the poor can invest in their families’ health and educational needs and make a significant impact on the development of their communities. By most industry estimates, less than 20% of the demand for microcredit from the world’s poor entrepreneurs is being met, a large opportunity for social investors like Deutsche Bank to make a real impact by developing funding structures to channel capital to these communities.”[ix]

To summarize, whether it is the present untimely (huge) investment in SKS (an MFI under fire from the regulator and having increasing ghost clients/frauds as per its own admittance) to supporting the illegal operations of LAPO[x] (Nigeria) some years ago and attempting to cover up the same (Mr Asad Mahmood tried to do so as per Hugh Sinclair’s book and related communication)[xi], Deutsche Bank has an immense amount of explaining to do. And going by the same transparency principle (that Deutsche Bank claims to have helped create for MFIs), it is time that Deutsche Bank comes clean on its global micro-finance investment story! Let us be clear on that!

And for the record, I must clarify that despite several e mails to Mr Asad Mahmood, the public face of the Community Development Finance Group (CDFG) at Deutsche Bank, there has been no reply what-so-ever till date from him[xii]

Some of the key questions that Deutsche Bank (and its senior management) would need to provide answers to include (but are not limited to) the following:

a.   Why did Deutsche Bank invest in SKS at a time when even the regulator (Chairperson, IRDA) saw massive problems with its (insurance) operations? 

b.   How could Deutsche Bank invest in SKS despite admittance by the company to presence of ghost clients and frauds in its micro-finance operations? It must be remembered that these have increased in absolute terms as compared to the past as an earlier Moneylife article shows (Increasing frauds, internal lapses at MFIs: Need to strengthen supervisory arrangements to protect the poor)

c.   How did Deutsche Bank invest in an Indian MFI when it (publicly claimed and) thought it unfit to even lend money to Indian MFIs? Please see statement reproduced from Deutsche Bank’s website – “While India is one of the largest potential markets for microfinance, Deutsche Bank currently does not have any loans to microfinance institutions there due to the rapid commercialization of the sector and concerns with pricing of the loans to poor clients.”[xiii]

d.   The Deutsche Bank website notes that, “Deutsche Bank's MFI clients must meet standards of good governance, transparency, and interest rates that are reasonable within the country and regional context.” If that was the norm, then, how did Deutsche Bank invest in LAPO (Nigeria), which, according to public domain information,  suffered from several weaknesses including: a) illegal collection and intermediation of savings; b) inordinately high (effective) interest rates touching 144% under specific situations; c) an illegal loan product (perhaps) because illegal savings collection was a part of it; d) conflict of interest in terms of the auditor being related to the CEO and other such issues; e) high levels of client desertion; f) lack of transparency with regard to data (which led to MicroRate’s subsequent withdrawal of its rating); and g) poor governance among other things.  

e.   Who coordinates the various Deutsche Bank investments in micro-finance? According to their focus magazine, it is the community development finance group (CDFG) that coordinates this! If so, how did the CDFG recommend SKS Microfinance despite the various on-going problems? At least, should not have Deutsche Bank waited until the enquiry by the regulator was over?

f.    And last but not the least, why did the same Deutsche Securities Mauritius Limited sell of its stake in SKS Microfinance just a few months ago (according to the Economic Times[xiv] as well as filings with the BSE) and then again buy back SKS Microfinance shares? Something peculiar is happening here!

As one of the world’s foremost global banks, the least I expect is an IMMEDIATE internal enquiry into the micro-finance operations of all its subsidiaries (and not just the CDFG) and redressal of any weaknesses/short comings so that investments made by Deutsche Bank are: a) in accordance with the law and seen to be seen as such; b) safe and sound from an investor/systemic perspective; and c) most importantly, ethical from a transparency stand point. Only time will tell whether this happens at Deutsche Bank AG …and I hope that the recently appointed (Co) CEOs of Deutsche Bank AG … Juergen Fitschen and Anshu Jain…set in motion the various processes to address these controversial micro-finance investments and issues related to these immediately…Otherwise, the image of Deutsch Bank with regard to its role in global micro-finance will continue to take a pounding…  

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[i] Does Sinclair’s Open Challenge (to the Global Micro-Finance Industry) Make His Claims True? and Hugh Sinclair's Response to My Earlier Post - "Does Sinclair’s Open Challenge (to the Global Micro-Finance Industry) Make His Claims True?"

[ii] The exchange rate on 25^th July 2012 was Rs.56.0465 = 1 US $. This would mean that the total investment was of the order of over US $ 13.90 Million (Source: http://www.oanda.com/currency/converter/) 

[iii] http://timesofindia.indiatimes.com/business/india-business/Deutsche-Securities-mops-up-9-15-in-SKS-via-QIP/articleshow/15169644.cms

[iv] http://www.sebi.gov.in/FIIIndex.jsp?fiiIndxName=D

[v] http://investing.businessweek.com/research/stocks/private/snapshot.asp?privcapId=36660922

[vi] Source: Quoted from http://www.thehindubusinessline.com/industry-and-economy/banking/article3446545.ece

[vii] Source: Quoted from http://www.moneylife.in/article/sks-microfinance-employees-swindle-rs158-crore/27247.html. The Moneylife article was based on the SKS annual report and so, the annual report must have been released earlier than the date of the news item.

[viii] Increasing frauds, internal lapses at MFIs: Need to strengthen supervisory arrangements to protect the poor

[ix] https://www.db.com/usa/content/en/1077.html

[x] Please see the following articles in this regard: Why blame the MFIs alone?; Should not microfinance investment vehicles be judged by the same standards set for retail MFIs?; and Does Sinclair’s Open Challenge (to the Global Micro-Finance Industry) Make His Claims True?)

[xi] Please see the following articles in this regard: Does Sinclair’s Open Challenge (to the Global Micro-Finance Industry) Make His Claims True?

[xii] Please see the following articles in this regard: Does Sinclair’s Open Challenge (to the Global Micro-Finance Industry) Make His Claims True?

[xiii] https://www.db.com/usa/content/en/1077.html

[xiv] http://articles.economictimes.indiatimes.com/2012-07-26/news/32869385_1_sks-microfinance-deutsche-securities-stake

Triple Jump’s Response to Hugh Sinclair’s Book: Does It Raise More Questions than Provide Credible Answers?

Ramesh S Arunachalam

In his recent book, “Confessions Of A Microfinance Heretic: How Microlending Lost Its Way And Betrayed the Poor”, Hugh Sinclair has made several strong claims (Why blame the MFIs alone?; Should not microfinance investment vehicles be judged by the same standards set for retail MFIs?; and Does Sinclair’s Open Challenge (to the Global Micro-Finance Industry) Make His Claims True?) with regard to Triple Jump in the now famous LAPO, Nigeria case. And to try and verify Sinclair’s claims, we did some background research on Triple Jump (TJ) and also requested them for feedback with regard to the claims made by Hugh Sinclair.  Here is what we found… read on….

First, for some background on Triple Jump and then to the actual LAPO case…

 

The Triple Jump Annual Report 2007[i], dated May 2008, (Page No.13), notes that,

“Triple Jump is convinced that growth and reinforcement of the microfinance sector is an important precondition to the social-economic development of these groups. As such, the existence of solid and professional MFIs is essential. A number of instruments can help MFIs realise their full potential. After the initial phase, which may involve donations, we are referring to:

·         Advisory services to improve the performance of the institution

·         Equity to strengthen the capital base

·         Loans for enlarging the microfinance portfolio

Triple Jump seeks to stimulate the economies of developing countries from the bottom upwards. Helping MFIs to grow and become more professional is our way of broadening access to a whole range of financial services for small entrepreneurs in developing countries. MFIs go through various stages in their development: emerging, expanding and mature. Triple Jump supports them during all these stages. The needs and requirements vary per phase and depend on the context of the MFI, so we advocate a tailor-made approach customized to suit the individual situation of the MFI.”

Please see figure 1 below that contextualizing various funds at Triple Jump.

The Triple Jump Annual Report 2007, dated May 2008 (Page No.15), further notes that:

“Triple Jump forms a link between the western capital markets and the financial sectors in developing countries. We manage a broad spectrum of funds specializing in microcredit and we provide a wide variety of services designed to support MFIs in the three stages of their development: emerging, expanding and mature.

Triple Jump focuses on MFIs which are committed to:

·         reducing poverty in their society

·         reaching low-income and vulnerable groups, particularly women

·         respecting society and the environment

·         achieving maximum efficiency, financial sustainability and outreach.”

The Triple Jump Annual Report 2007, dated May 2008, Page No.18, then describes the investment process as shown in Figure 2 and 3 below

Now for the most imporatnt aspect – due diligence due by Triple Jump – and please read this carefully. As the Triple Jump Annual Report 2007, dated May 2008, Page No.19, notes

“One of the characteristics that distinguishes Triple Jump from its competitors is its thorough due diligence process. At Triple Jump, we put great emphasis on carrying out the client assessment ourselves. As such, our due diligence process is an essential part of the Triple Jump approach. It not only allows us to analyse investment risk, but also helps us to build a strong relationship with our partners and to learn from them. Our assessment focuses on the legal, organizational, commercial and financial aspects of the organization, as well as a thorough analysis of market and country risks.”

The same report (Page No.19) further notes that:

“Risk management is an important aspect of portfolio management. Triple Jump assesses risk with a thorough pre-investment analysis, disciplined monitoring, a problem-solving attitude, and the diversification of investments.

·     Triple Jump uses risk assessment tools to assess the financial and operational aspects of investments, adjusting for market- and investment-specific factors. As part of a continuous effort to improve our investment decision-making process, Triple Jump has introduced a new risk scoring system so that the level of risk associated with potential investments can be better evaluated and calibrated.

·     The web tool enables regular monitoring of the portfolio, with early warning systems in case of changes in performance.

·     Portfolio diversification in terms of countries, regions, currencies and types of institutions reduces the risk for each portfolio.”

Having set this background, let us move to the facts in the LAPO Case. MicroRate's 2007 rating report (Lift Above Poverty Organization (LAPO) Rating Report by MicroRate, December 2007) clearly mentions the following:

1.      “’Client savings intermediation without a license and without an appropriate structure’ as a weakness” (Page No. 1)

2.      "Borrowings are well diversified among a large number of mainly foreign lenders. Approximately one-third of funding is provided by client deposits even though as an NGO, LAPO is not licensed to mobilize savings." (Page No. 5)

3.      "With a cost of only 4%-5%, savings deposits are a much cheaper source of funding than commercial credits. Recognizing this, LAPO has strongly pushed savings mobilization. In MicroRate's opinion, this policy bears a serious risk since as a NGO, LAPO is neither authorized nor adequately equipped to mobilize savings from the public." (Page No. 5)

4.      "LAPO's present policy using savings deposits to fund its operations-besides being illegal-exposes its clients to risks of which they are unaware." (Page No.6)

The ratings and other public domain material also pointed to other serious issues and weaknesses in the investee (LAPO) apart from its illegal collection and intermediation of client savings: a) an illegal loan product (perhaps) because illegal savings collection was a part of it; b) inordinately high interest rates; c) conflict of interest in terms of the auditor being related to the CEO and other such issues; d) high levels of client desertion; e) lack of transparency with regard to data (which led to MicroRate’s subsequent withdrawal of its rating); and f) poor governance among other things.

That being the case, the key question that arises here is”

How did Triple Jump’s unique DUE DILIGENCE process (as claimed in its annual report of 2007, dated May 2008) allow investment in LAPO when there was so much (potentially damaging) public domain information available with regard to illegal collection and intermediation of client savings by LAPO as well as other weaknesses?

This question needs serious and transparent answers from Triple Jump and its statement (sent to the author by e mail and shown as Exhibit 1 below) hardly provides any answer with regard to the serious issues at hand.

In fact, a look at Exhibit 1 shows that Triple Jump has made a number of statements and one of them is given below:

“The book speaks of Triple Jump misleading and angering its principles fiver year ago. Again, this statement is demonstrably false. Our principals have at the time all confirmed to have been correctly informed and still are very satisfied with the services Triple Jump provides them. In fact, all have increased the amounts entrusted to Triple Jump significantly over the years.” (4^th Paragraph, Page 1, Triple Jump’s Response, Dated July 2012)

This statement has very serious repercussions and let us gets into this further by looking at the ASN – Novib Fund annual report 2007[ii], dated 19 March, 2008, (Pages No. 8 and 9) which notes the following under the head, LAPO, Nigeria:

“In February the ASN-Novib Fund approved a loan of EUR 1 million to LAPO in Nigeria. LAPO is the second microfinance institution in Africa to which the ANF has provided a loan. Various studies have revealed that Nigeria is one of the poorest countries in the world. For more than 30 years Nigeria has been rocked by unrest and military regimes, with the result that the country has barely developed. The majority of the people have had to rely on income from their own small-scale activities which lend themselves exceedingly well to micro-funding. Although micro-credit is still in its infancy in Nigeria, with a loan portfolio of USD 7.5 million and 84,000 customers LAPO is the absolute epitome of micro-lending in that country. LAPO has made the leap from receiving a loan from the Oxfam Novib fund for less developed organisations to one from the ASN-Novib Fund for more mature organisations. LAPO services the poorest population groups in Nigeria. LAPO’s internal surveys of its customers have revealed that their circumstances have improved by 80% compared with the situation prevailing before they had received a loan from it. In conclusion LAPO is actively involved in the development of Nigeria’s national regulations governing microfinance institutions, which will provide legal protection for any savings which poor people hold with such organisations.”

Now given the facts that existed with regard to LAPO in the public domain and its illegal collection/intermediation of client savings, several key questions arise:

            

a.       How did ASN Novib Fund get this impression (especially related to client savings)?

b.      How can LAPO be the ‘absolute epitome of micro-lending’ in Nigeria, when public domain information clearly stated that it was involved in illegal collection and intermediation of client savings and also had many such weaknesses?

c.       How did the ASN Novib Fund come to these conclusions when public domain information (MicroRate, 2007) clearly stated otherwise?

d.      Did Triple Jump do anything to correct ASN NOVIB Fund's wrong impressions given above?

e.       What did Triple Jump's reports (due diligence reports as well as subsequent reports) to ASN Novib fund actually state about LAPO, its illegal collection/intermediation of client savings and other weaknesses?

These are unanswered questions indeed and they certainly merit an answer from the ASN Novib Fund as well as Triple Jump. In fact, when I asked Triple Jump to prove Sinclair’s assertions as false (as they had said in their response that his claims are DEMONSTRABLY FALSE), I just got an answer saying that

“Mr. Sinclair’s assertions in his book regarding Triple Jump are incorrect. The assertions pertain to an episode of 5 years ago and are neither relevant for the industry as a whole nor for the way Triple Jump operates. The passages you refer to are at best moderately readable fiction that we think best left for account of the author.” (E Mail sent to author by Triple Jump, Dated July 9^th, 2012)

I am sorry but I am concerned with the above response from Triple Jump because MIV’s (Micro-Finance Investment Vehicles) can neither operate above the law nor be seen to operate above the law. Therefore, dismissing Sinclair's claims as irrelevant to either the global micro-finance industry or Triple Jump's operations is certainly not acceptable. 

Without any doubt, MIVs need to be (made) as accountable and as responsible as MFIs – make no mistake about that! In fact, much of the crisis in India was fuelled (perhaps) because of the irresponsible investments (debt and equity) made by many stakeholders including MIVs. And let us therefore understand that the first dictum of responsible micro-finance is RESPONSIBLE INVESTING. We certainly cannot have MFIs practice responsible micro-finance on the ground when their investors are ‘irresponsible’. That needs to be understood and appreciated by the global micro-finance industry!

And before I sign off, I want to state that my purpose in doing this research and analysis is not just to provide support for Hugh Sinclair’s claims. More importantly, I think that if there are real issues in what he has said, we must address these in a fair and square manner. That is the hallmark of a learning industry that desires to bring about (lasting) change in the lives of the poorest people.

Also, often times, when issues like this crop up, the normal response is to change CEO or management or do something equivalent. That, in my opinion, is (perhaps) not the right approach. People/institutions could make genuine mistakes and they need to be given a fair opportunity to:  a) reflect on what went wrong and why; and b) also, set in motion, the necessary changes. But, when given such an opportunity, they must CERTAINLY bring in corrective (systemic) changes to their strategic and operational processes so that PAST mistakes do not get repeated. And that is something that I hope that the ASN Novib Fund and the mutual fund regulator in Netherlands would like to ensure has happened at Triple Jump as well as other fund managers – so that the primary investor(s) in micro-finance as well as end user clients are indeed well protected…

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[i]http://www.mixmarket.org/sites/default/files/medialibrary/1501.3028/Triple_Jump_Commercial_Annual_Report_2007.pdf

[ii] www.asnbank.nl/blob.asp?id=14214

Should not microfinance investment vehicles be judged by the same standards set for retail MFIs?

Ramesh S Arunachalam

While much has been mentioned globally with regard to governance, systems, management and transparency for retail MFIs, the time has now come to apply the same yardsticks to MIVs and all other stakeholders who invest in microfinance

It was early the 1980s and I happened to have a fascinating meeting with a fine gentleman (a noted British academic and practitioner) in the development sector and he said a lot of things that have stayed in my memory and I relate one such statement here – ‘it is ironic that we sit from where we do and preach to others on what they should do at the grass-roots. And it becomes even more ironic when we do not practice what we preach’.

Viewed in this context, governance, systems, reporting and transparency are key words that I have heard a lot in the microfinance sector (from bi-lateral and multi-lateral donors, global funds, banks, investors and others) over the last two decades and especially, in the last few years. At many conferences, I have heard these (high and mighty) stakeholders literally ram these ideas into the heads of MFI practitioners. While much of this has been mentioned globally with reference to RETAIL micro-finance institutions (MFIs), I think that the time has now come to apply the same yardstick to Micro-Finance Investment Vehicles (MIVs)[i] and all other stakeholders who invest in micro-finance (be it multi-laterals, bi-laterals or others).

Without question, MIVs and other investors must subject themselves to the same scrutiny and standards that they expect of retail MFIs that they invest in. And you will appreciate this fact more when you read Hugh Sinclair’s recent book, “Confessions of A Microfinance Heretic: How Microlending Lost Its Way And Betrayed the Poor”

Sinclair essentially talks about the case of a few MIVs and other stakeholders who invested in LAPO despite knowing LAPO’s serious limitations (Please see previous Moneylife article Why blame the MFIs alone?). Indeed, MIVs and global banks have a lot of explaining to do with regard to why they invested in LAPO (in the first place) despite public domain material that pointed to serious weaknesses in the investee: a) illegal collection of savings; b) inordinately high interest rates; c) an illegal loan product (perhaps) because illegal savings collection was a part of it; d) conflict of interest in terms of the auditor being related to the CEO and other such issues; e) high levels of client desertion; f) lack of transparency with regard to data (which led to MicroRate’s subsequent withdrawal of its rating)  ; and g) poor governance among other things.

Without any doubt, the sanctity of these MIVs investing in LAPO can indeed be questioned on the basis of evidence available in the public domain. That said, I am however unable to accept Sinclair’s (implied conspiracy) argument that the investors (some MIVs and banks) did this on purpose as there is no serious evidence in the book that permits me to come to such a conclusion independently. I would certainly prefer to give these MIVs and banks the benefit of the doubt. Perhaps, sloppy due diligence (including inadequate scanning/reading of publicly available material) and/or short cuts adopted (cut paste presentation of credit proposals to different investors) may have resulted in this failure caused primarily by lack of appropriate systems, governance and management. And to be fair to these 1^st round investors, many of them pulled out after the lid was blown on LAPO (and its illegal operations/other weaknesses) - which is perhaps a tacit acknowledgement by them of their mistake and/or error of judgment in the first place. However, the later (round) investors in LAPO – like responsAbility and Blue Orchard – still have a lot of explaining to do indeed.

That said, there is a larger point that I get from Sinclair’s book. It is the fact that even large and LuxFLAG labeled MIVs (emphasis added) like responsAbility invested in LAPO when a lot of this information was available in the public domain. Please see investments by responsAbility in LAPO as per timelines given below:

Investor	Investee	Region	Amount (USD)	Type and Date
responsAbility Global Microfinance Fund	LAPO	SSA	750,000	Debt, September 2009
responsAbility SICAV Mikrofinanz-Fonds	LAPO	SSA	250,000	Debt, September 2009
Source: CGAP Microfinance Dealbook Quarterly Review - Third Quarter 2009, Page No.3 and 4, www.microcapital.org/downloads/Dealbook/Dealbook_3Q2009.pdf

Perhaps there were more investments by responsAbility but I have no idea as data is scarce. The Planet Finance rating report (2011) says that the “Main international funders include responsAbility (transaction advised/organized by PlaNis[ii] –15% of total funding), Blue Orchard (7.5%), and Microcredit Enterprise (4%).”(Lift Above Poverty Organization (LAPO) Rating Report by Planet Rating, February 2011, Page No.5)

The key question here is how did responsAbility and Blue Orchard make this investment decision when public domain material on LAPO - being involved with illegal intermediation of client savings and having several other serious weaknesses - existed at the same time? Why did these funds invest in LAPO when others MIVs and stakeholders were pulling out? And how were the interests of primary investors in responsAbility and/or Blue Orchard safeguarded?

One may argue that responsAbility is LuxFLAG labeled but that hardly provides any comfort as when I tried to get to LuxFLAG (http://www.luxflag.org/) and look at if any documents of responsAbility were available, I found none for the specific period (when the investment in LAPO was made). So much for the labeling and associated comfort that it is said to provide with regard to MIV operations. Please see Exhibit # 1 below that provides tangible evidence in this regard and I have print screens with regard to the non-availability of all these specified reports given in the Exhibit.

 

And if you look at the luminis database (https://www.luminismicrofinance.com) – which is a good start to having publicly available information on MIVs, the pressure to invest may have been huge for responsAbility as shown in Exhibit # 2 (sourced from luminis database at https://www.luminismicrofinance.com)

Much of the same argument goes for the Dexia Micro-Credit Fund (Blue Orchard Finance) which is another large LuxFlag labeled MIV. Apart LAPO, Blue Orchard invested in MFIs like Sahayata Micro-Finance in India, whose operations did come under a cloud, especially after the 2010 Indian micro-finance crisis. Please see previous Moneylife articles in this regard (i) Award winning Sahayata Microfinance is the latest to go astray; and (ii) What is said at conferences is very different from what is implemented in practice

Investor	Investee	Region	Amount (USD)	Type
Dexia Micro-Credit Fund (BlueOrchard Finance)	Sahayata	SA	1,000,000	Debt and August 2009
Source: CGAP Microfinance Dealbook Quarterly Review - Third Quarter 2009, Page No. 3, www.microcapital.org/downloads/Dealbook/Dealbook_3Q2009.pdf

Blue Orchard’s other investments in India are also of questionable nature, became they were made in MFI(s) that were directly linked to the irresponsible and phenomenally high (portfolio) growth that caused the 2010 Andhra Pradesh (AP) micro-finance crisis in the first place. Therefore, it appears that investments decisions of MIVs (like responsAbility and Blue Orchard) need not necessarily be aligned to grass-root reality.

That is a very critical point that needs emphasis and it certainly deserves attention of key stakeholders in the global micro-finance value chain – so that MIVs acquire the governance, systems and management necessary to invest appropriately and thereby protect their primary investors. Some may argue that LuxFlag’s attempt to certify MIVs is a step in that direction. Probably yes but a lot more needs to happen on the ground. And indeed, if the LuxFLAG label is to be taken more seriously, we also need transparent and accountable information with regard to the entire process of certification – so that we can judge for ourselves the quality of due diligence applied prior to certification, information so collected and so on.

Friends, in short, for me, Hugh Sinclair’s book was indeed a revelation about how MIVs operate in the international supply chain of delivering financial services to low income people. And after reading the book, I am searching for answers to questions such as (but not limited to) the following:

a)      How do MIVs make investment decisions? What systems do they have to ensure that the pressure to lend/invest does NOT result in poor investment? Should not MIVs have minimum governance standards and internal audit requirements just as RETAIL MFIs do? (Please see previous Moneylife articles (i) How to make the boards of large NBFC MFIs implement corporate governance norms in practice? (Part I); (ii) Corporate governance: What boards of large NBFC MFIs can do on the ground? (Part II) and (iii) Independent internal audit is the key to implementing responsible microfinance in MFIs)

b)      How do MIVs protect the overall interest of their primary investors? What systems do they have to ensure this in real time? What else may be necessary given the experiences narrated in the LAPO case?

c)      What standards of governance, transparency and reporting are MIVs currently subject to? Who sets these standards and who enforces them? How adequate are these?

d)      Given the huge diversity in legal form, location (place of incorporation), products, what can be said about the regulation and supervision of MIVs in an overall sense? And specifically, who regulates these MIVs? Who supervises them? What is the role of central banks in all of this? And does this regulation/supervision afford any protection to the primary investors in these MIVs?

e)      Last but not the least comes the question of whether (or not) there is any regulatory arbitrage? That is a very key issue indeed and will be dealt with in a separate article.

I do hope that bodies (like CGAP) in the global micro-finance industry play a constructive role in looking at issues such as the above and facilitating the necessary changes on the ground. And if that happens, I am sure that Hugh Sinclair’s book would have made a significant difference to the practice of micro-finance globally…   

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[i] “MIVs, also known as microfinance funds, are entities that invest in MFIs. For a fund to qualify as an MIV, it must meet the following criteria: (i) The investment vehicle must be an independent legal entity (i.e. independent of the MFI being funded); (ii) Multiple private investors must be present, or the vehicle must be open to such investors; and (iii) The investment vehicle must focus on investing in microfinance” (Source: http://www.microrate.com/)

[ii] Disclosure statement: PlaNis and Planet Rating are two distinct legal entities, operating in a strictly independent manner. Planet Rating does not disclose to PlaNet Finance any information that is not publicly available to all other investors or fund providers. Planet Rating’s internal Rating Committee is fully independent, private, and confidential.