Strategic Design for the Bottom of the Pyramid Financial Markets
Micro-financing in Bangladesh
By Richa Agarwal
Issue 7 Spring 2011
Executive Summary
BRAC’s Microfinance program is one of the oldest initiatives of its kind in Bangladesh. Programs that were founded in 1974 are beginning to be more widely recognized as a sustainable framework to help the impoverished and marginalized population help themselves. Through their system of connecting social enterprise with development programs, BRAC has supported the consequent effects of successful microfinance, such as employment generation and entrepreneurial growth. In this article, Design Management Consultant Richa Agarwal discusses the wider implications of microfinance in a global market, as well as the positive effects of strategic design on the microfinance process as a catalyst for sustainable economic development.
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Unsustainable Financial Paradigm
Every interaction from birth shapes human behavior. The desire for objects precedes the ability to verbalize those desires. Desires fuel the voracious appetite for products that help define our identity. Consumption of these products is the foundation of the American economy; during a recession, the middle class is expected to spend and help the economy get back on the path to exponential growth. Traditional economic theory dictates that the increased spending is directly proportionate to GDP growth. Executive pay and incentive structures are tied to consumption patterns. The more companies can sell, the better quarterly results will be, leading to increased stock prices, and a growing economy. We live in this paradigm.
This short-term outlook has propelled consumers and investors toward making some very risky choices. The American subprime crisis resulted from this short-term economic orientation and our propensity to consume well beyond our means. The addiction to credit for instant gratification of our desires, coupled with the access to cheap goods, led to some irresponsible behavior. Consumers bought houses they could not afford, some hoping to sell them to make a quick profit. Banks and creditors exploited this weakness fully by providing consumption loans and granting variable rate mortgages without the required due diligence. Compounding this problem was the bundling of these risky mortgages into CDOs (collateralized debt obligations)1 whose incorrect ratings (by the rating agencies)2 exposed investors to unforeseen risks.3 Eventually, this combination of greed and unscrupulous practices brought the American financial system to its knees. The effects of this collapse reverberated in the capital markets around the globe, a testament to the interconnected world we inhabit.
The BOP “Subprime”
In the relatively nascent capital markets that serve the BOP4 (bottom of the pyramid) customers, a similar trend is unfolding5. The microfinance industry provides financial services to the BOP customers who cannot access conventional banks due to economic and geographical barriers. These customers have traditionally relied on the informal financial sector, such as payday lenders and loan sharks for access to capital. Nobel Laureate Muhammad Yunus popularized microcredit for BOP customers as an alternative to paying exorbitant interest rates for accessing capital. Through microfinance institutions (MFIs), poor people can access financial services such as micro-credit (small loans), savings, insurance, and remittance.
Up until recently, micro-credit customers have maintained high loan repayment rates, in some cases exceeding 99%. As the subprime crisis unfolded, the portfolios of MFIs remained strong due to high loan repayment rates, causing large institutional investors to take note. Last July, giant investors Sequoia capital and George Soros backed SKS Microfinance Ltd., an Indian micro-credit lender that raised its initial public offering to as much as $347 million after six quarters of gains6. The MFIs accessing mainstream capital markets for equity raises many ethical questions7. When MFIs are beholden to shareholders, MFI managers are expected to deliver quarterly results. This will motivate and pressurize MFIs to increase the size of their portfolios to meet growth objectives. Therefore, the same paradigm that fuels the consumption in western markets is transferred to the BOP markets.
Other MFI’s hoping to follow SKS’s example, started dumping loans in the market, expecting to grow their loan portfolios at exponential rates. Conventional wisdom demands that microfinance institutions conduct due diligence before approving a micro-credit loan, and verify the customers’ ability to pay as per the agreed terms. Some MFIs driven by short-term profit motives started disbursing micro-loans to consumers who were already struggling to pay existing loans, trapping people in multiple loans. MFIs driven to deliver quarterly results exerted severe pressure on clients who could not pay back the loans.
“In the last few months, the harassment and shame from creditors causing a scene was so intense that some clients committed suicide in the Indian state of Andhra Pradesh”8.
The media and politicians have accused MFIs of acting unethically and the repercussion of these events has shaken the MFI industry, resulting in defamation of the entire MFI sector. Ceding to public outrage, the Indian government passed a string of regulations that are not in the best interest of the MFI clients nor the industry in general9. Echoing the Indian government’s response, the neighboring Bangladeshi government responded by capping microfinance interest rates in their own country, the most saturated MFI market in the world. The microfinance industry suffered backlash from stakeholders who chastised the industry across the board due to the unethical behavior of a few. Former Reserve Bank of India governor, Y.V. Reddy, compared the current crisis in Microfinance to the American Subprime crisis10. In both cases, the subprime and the financial crisis, the combination of greed and the desire for short-term gains to appease stockholders remains constant.
Strategic Design for BOP Financial Markets
The issues with the microfinance sector are not systemic but are related to program design and implementation. At Pratt’s Design Management program, I co-authored a thesis addressing Design Management strategies that can aid MFIs in creating value for all stakeholders, similar to any other business. Microfinance is especially well suited for the Design Management applications because it advocates the promotion of the United Nations Millennium Development goals, a core component of the program. The field of Design Management advocates a triple bottom line approach to conducting business, beneficial for social enterprises such as MFIs whose main goal is poverty alleviation11.
Seven Design Management focus areas and corresponding strategies that can spur institutional growth while creating value for the stakeholder community and the planet are:
Leadership: To distinguish the leadership role of MFIs in serving the BOP financial marketplace, engage with stakeholders in influencing policy and analyze opportunities for partnerships
Culture: To understand the clients’ perceptions of the lending models based on cultural axioms when considering program design
Communication: To design an effective internal and external communication strategy for MFI’s to deliver a cohesive message to all stakeholders
Marketing: To deploy creative, ethical and sustainable marketing solutions in growing institutions and scaling up programs
Branding: To create branding strategies and collateral that advance the MFI’s mission and attract the right partners, investors, and donors
Process & Technological Innovation: To create innovative processes and leveraging technologies to maximize value for all stakeholders
Customer Service: To evaluate the customer processes with the customers’ lens, not an institutional lens, in designing customer service initiatives.
BRAC: Sustainability through Strategic Design
Microfinance is a tool for poverty-alleviation, not an instrument for exploiting the most vulnerable sectors of society. Microfinance programs designed to deliver maximum value to their clients can also maximize their social and financial return on investment. BRAC, a southern NGO founded in Bangladesh in 1972, is one of the best examples of an institution that has used several design management strategies effectively in serving the BOP markets. BRAC began in 1972 as a small relief effort in response to Bangladesh’s war of liberation, which left the country torn by poverty and strife. Over the past 38 years, BRAC has developed, tested and implemented a multitude of development programs and social enterprises that have propelled it into one of the largest development organizations in the world. BRAC currently touches the lives of more than 138 million people through its poverty-alleviation focused programs including microfinance, education, health services, employment opportunities and human rights education. BRAC has issued $6 billion in micro-loans to nearly eight million borrowers, provided basic health services to more than 92 million people and graduated over six million students from its pre-primary and primary schools. Together with its portfolio of social enterprises in SME12 lending, dairy, agriculture, and others, BRAC has created 9.1 million jobs in Bangladesh.
BRAC’s vision is to create a world free from all forms of exploitation and discrimination where everyone has the opportunity to realize their potential. BRAC’s mission is to empower people and communities in situations of poverty, illiteracy, disease and social injustice13. BRAC’s programs aim to achieve large scale, positive changes through economic and social programs that enable men and women to realize their potential. Today, BRAC has an 18-country footprint, with programs in 10 countries, provision of technical assistance in 9 countries, and affiliate offices in the UK and US.
BRAC’s holistic approach has given millions of clients a path out of poverty. BRAC is largely self-funded with revenues generated from its social enterprises that are strategically linked to its development programs. BRAC’s Aarong brand, a retail chain of life style stores in Bangladesh employing 65,000 rural Bangladeshi women artisans, is an ideal example of BRAC’s social enterprise relationships to its development programs14. The rural artisans and micro-entrepreneurs that supply Aarong with Bangladeshi handicrafts and heritage products are clients of BRAC MFI programs. In addition, Aarong also provides these women with design services and raw material inputs for their businesses. Many of these small vendors have become so successful that they have gone on to supply, not just Aarong, but other retailers in the market as well.
Hasina Khatun is representative of the Aarong’s vendor base comprising of micro-entrepreneurs who are also clients of BRAC’s microfinance programs. Hasina and her daughter-in-law run a small sari-weaving business near Manikganj, a small town seventy kilometers away from Dhaka, and have been supplying saris to Aarong for the last ten years. Hasina started her business with 50 USD from BRAC’s microfinance program. In ten years, she has managed to grow her business to employ four other women from her village. She is earning an average income of between six to seven thousand US dollars per year. The estimated 2009 GDP per capita in PPP15 terms for Bangladesh was approximately 1300 USD16 so Hasina is doing well for herself and her family.
Designing the Sustainable Paradigm
BRAC has utilized design management strategies to create desire for local products that provide a revenue stream for many of BRAC’s MFI clients.
Aarong, a popular shopping destination, has a strong brand presence in Bangladesh. Through Aarong, BRAC has revitalized the cottage industry, provided employment for microfinance clients and encouraged sustainable consumption, creating value for all stakeholders. Aarong’s revenue exceeded 40 million USD last year, a testament to a successful company that truly subscribes to the triple bottom line approach. The revenue generated from BRAC’s social enterprises is used for funding BRAC’s core programs in microfinance, health, education, livelihood development, legal aid and women’s empowerment, just to name a few.
Whether it is design for the developed world or for the bottom billion, the principles of Design-Management remain constant. The desire for products and services fuels innovation; if the purveyors of these desires were driven by maximizing value for all stakeholders and not short-term profits for themselves, the current economic paradigm could be replaced by one that is sustainable.
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CATALYST INSIGHT:
STRATEGIES IN ACTION:
Leadership:To distinguish the leadership role of MFIs in serving the BOP financial marketplace, engage with stakeholders in influencing policy and analyze opportunities for partnerships
Culture: To understand the clients’ perceptions of the lending models based on cultural axioms when considering program design
Communication: To design an effective internal and external communication strategy for MFI’s to deliver a cohesive message to all stakeholders
Marketing: To deploy creative, ethical and sustainable marketing solutions in growing institutions and scaling up programs
Branding: To create branding strategies and collateral that advance the MFI’s mission and attract the right partners, investors, and donors
Process & Technological Innovation: To create innovative processes and leveraging technologies to maximize value for all stakeholders
Customer Service: To evaluate the customer processes with the customers’ lens, not an institutional lens, in designing customer service initiatives
BRAC: Sustainability through Strategic Design
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About the Author:
Richa Agarwal, Consultant
Richa Agarwal, a Design Management Consultant and Project Manager with BRAC USA, recently merged her twelve years of experience in the New York fashion industry with her passion for microfinance. Richa works with BRAC’s largest social enterprise Aarong in Bangladesh, employing 65,000 rural artisans. Richa currently oversees special projects, funded by the Bill and Melinda Gates Foundation that will increase Aarong’s capacity to provide employment to more Bangladeshi rural artisans. Richa has worked in the apparel-manufacturing sector with some of the premium apparel brands such as Polo Ralph Lauren, Calvin Klein, and Phillips Van Heusen. Her roles with these companies have encompassed working with cross-functional teams that were responsible for the product development and manufacturing processes. Richa was educated at Boston University, FIT and is a graduate of the Design Management program at Pratt Institute.
FURTHER READING:
BRAC USA, Microfinance – www.brac.net/content/microfinance
Aarong – http://www.aarong.com/index2.php
Microfinance in India Compared to the American
Subprime Crisis – http://www.economictimes.indiatimes.com/news/economy/indicators/microfinance-in-india-is-like-subprime-lending-y-v-reddy/articleshow/6972903.cms3
REFERENCES:
1 Eavis, P. (2007, November 26). CDOs explained. Fortune, Retrieved from http://money.cnncom/2007/11/24/magazines/fortune/eavis_cdo.fortune/index.htm
2 Leone, M. (2008, July 8). Subprime slam: SEC exposes rating agency faults. CFO, Retrieved from http://www.cfo.com/article.cfm/11699984?f=related
3 Evans, D. (2007, June 1). Banks sell ‘toxic waste’ CDOs to Calpers, Texas Teachers Fund. Bloomberg, Retrieved from http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aW5vEJn3LpVw
4 BOP – a term referring to the collective of the poorest people on the planet, as defined by author CK Prahalad in his book The Fortune at the Bottom of the Pyramid, The: Eradicating Poverty Through Profits.
5 Kazmin, A. (2010). Microfinance: small loan, big snag. Financial Times, Retrieved from http://www.ft.com/cms/s/0/a3edfeba-fd85-11df-a049-00144feab49a.html – axzz18yzffzv5
6 David, R. (2010, July 26). SKS microfinance IPO seeks as much as $347 million. Business Week, Retrieved from http://www.businessweek.com/news/2010-07-26/sks-microfinance-ipo-seeks-as-much-as-347-million.htm
7 Chang, C. (2010). Microcapital brief: initial public offering (ipo) of India-based microfinance institution (mfi) sks microfinance raises questions about ethics within the industry. Micro Capital Monitor, Retrieved from http://www.microcapital.org/microcapital-brief-initial-public-offering-ipo-of-india-based-microfinance-institution-mfi-sks-microfinance-raises-questions-about-ethics-within-the-industry/
8. MFI agents drive people to suicide for insurance cash. (2010, November 19). Deccan Chronicle, Retrieved from http://www.deccanchronicle.com/hyderabad/mfi-agents-drive-people-suicide-insurance-cash-405
9. Leave well alone. (2010, November 18). The Economist, Retrieved from http://www.economist.com/node/17522606?story_id=17522606&CFID=158333577&CFTOKEN=84755265
10. Nayak, G. (2010, November 23). Microfinance in India is like subprime lending: Y V Reddy. The Economic Times, Retrieved from http://economictimes.indiatimes.com/news/economy/indicators/Microfinance-in-India-is-like-subprime-lending-Y-V-Reddy/articleshow/6972903.cms
11. Agarwal, Baek, Fischer, Kirk, Design management opportunities within Microfinance, Institutions, Pratt Institute, 2009
12. Small and Medium Enterprises
13. Who we are: Mission. (2010, December 10). Retrieved from http://www.brac.net/content/who-we-are-mission
14. Social Enterprises: Retail, (2010, December 10). Retrieved from http://www.brac.net/content/social-enterprises-retail
15. Purchasing Power parity – A method for calculating the correct value of a currency, which may differ from its current market value. It is helpful when comparing living standards in different countries, as it indicates the appropriate exchange rate to use when expressing incomes and prices in different countries in a common currency, (2010, December 10). Retrieved from http://www.economist.com/research/economics/alphabetic.cfm?letter=P
16 Economy: GDP – per capita (PPP)- Bangladesh, (2011, January 4). Retrieved from http://www.indexmundi.com/g/g.aspx?v=67&c=bg&l=en