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India Knowledge@Wharton | Does microfinance need regulation?

India Knowledge@Wharton | Does microfinance need regulation?
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First Published: Sun, Jan 06 2008. 10 35 PM IST

Updated: Sun, Jan 06 2008. 10 35 PM IST
Nobel laureate Muhammad Yunus, founder of Bangladesh-based Grameen Bank, recently challenged Maharashtra, one of India’s most industrialized states, to compete with his homeland in the effort to end poverty. “Let’s see who eradicates poverty first—Maharashtra or Bangladesh,” he said.
Speaking in Pune in November, Yunus had pointed out that while microfinance in India has a lot of growth potential, an independent regulator needs to be set up to monitor cases of abuse.
Grameen Bank, which has so far loaned $6.5 billion (about Rs25,600 crore), is a highly successful micro lender. Starting by providing a loan of $27 to a group of impoverished women in the mid-1970s, Yunus has been a pioneer in using microfinance as a tool to lift people out of poverty. Grameen has 7.2 million borrowers, and Yunus says he hopes to eradicate poverty in his homeland by 2030 by leveraging the entrepreneurial zeal of poor Bangladeshis. “All poor people are entrepreneurs,” he said.
In India, microfinance is now a $2 billion business, but it could potentially grow to a size ranging from $10 billion to $30 billion. Despite the potential, Indian microfinance has its share of problems, according to Yunus. “The existing regulations are designed with commercial banking in mind, but microfinance requires a dedicated regulator and a relevant set of rules. Commercial banking is like a supertanker, whereas microfinance is like a dinghy boat with which you can reach small corners. If you design a dinghy boat with the architecture of a supertanker, it is sure to fail,” Yunus said.
Wharton management professor Keith Weigelt agrees that regulation might be necessary to ensure that some microfinance providers do not charge usurious rates of interest. Still, he urges caution. “If a regulator began to introduce rules, you have to wonder if that would drive microfinance institutions out of business... Now many microfinance institutions are trying to become like banks, and commercial banks are moving into microfinance. As a result, interest rates for microcredit loans have begun to come down. Moreover, credit agencies are starting to rate the microfinance providers. That, of course, is not the same thing as regulation, but it?is?a?market-based?solution.”
Why firing your worst customers isn’t a great idea
The idea is clear-cut: Low-value customers—the ones who hardly spend any money on your services or products yet tie up your company’s phone lines with questions and complaints—end up costing more money than they provide. So why not jettison them and focus your customer-relationship efforts on more profitable individuals? It sounds quite rational, and many corporations have jumped on the bandwagon. But a new study by two Wharton marketing professors, Jagmohan Raju and Z. John Zhang, and Wharton doctoral student Upender Subramanian, cautions that firing low-value customers may actually decrease firm profits, and that trying to increase the value of these customers may be counterproductive.
“Over time, companies have acquired a lot of capabilities in processing customer information,” Zhang says. “One thing (they) have done is to figure out who are their profitable customers, and they have concluded that firing low-value customers is a good idea. The problem, however, is that while this idea seems to make sense, it only makes sense in situations where there is no competition, which is very unlike the real world.”
For the majority of firms operating in a competitive environment, getting rid of low-value customers—or taking steps to turn low-value customers into high-value ones—leaves them open to successful poaching by competitors, the researchers say. If the competition knows that you have fired many or all of your low-value customers, they are likely to intensify their efforts to take your remaining customers away from you because they now know that all, or most, of those remaining customers are of the high-value variety.
“What our analysis tells us is companies make money, in part, by confusing their competitors about their customers,” Raju says.
So what is the proper way to manage relationships with low- and high-value customers? “Our research finds that a better approach is to improve the quality of your high-end customers at the same time that you keep your low-end customers, but you should find other, cheaper, ways to manage the low-value customers, such as encouraging them to use automated phone-response systems or the Internet or offering minimal discounts or other benefits,” says Raju.
KPMG’s Timothy Flynn on restoring credibility
For Timothy P. Flynn, chairman of the global accounting firm KPMG, ethics and integrity are not just boilerplate language in the company mission statement. Flynn, who gave a lecture as part of the 2007 Wharton Ethics and Leadership speaker series, became CEO of KPMG’s US partnership in 2005, just as former partners were being indicted for allegedly creating $2.5 billion in fraudulent tax shelters. “When I took over, it was a very challenging time for the firm,” he said. “There was a very real possibility that the tax situation could threaten our very existence.”
Leadership is important in assuring integrity throughout an organization, Flynn said, adding that even though only a few people at KPMG had behaved unethically, their actions slipped through a larger control system. To restore credibility to the firm as the indictments were about to be made, Flynn asked his partners for their trust and 90 days to re-establish relationships with employees and clients. On a conference call, he asked the partners to submit any questions they had for him by email. He answered all the questions the next day: “I took the toughest ones first and answered them straight-up.” He said the firm only lost five of 1,500 partners that summer and no Fortune 500 clients.
Finally, Flynn was asked if he has any regrets. He said his biggest struggles came in the wake of the tax-shelter scandal when he had to let partners go and refuse to pay their legal bills. “There were a lot of tough personnel and people decisions that I regret having to make, but I don’t regret making them.”
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First Published: Sun, Jan 06 2008. 10 35 PM IST