Harvard Business School (HBS) Prof. Michael Chu has helped deploy a $5.7 billion (Rs22,686 crore) private equity (PE) fund at Kohlberg Kravis Roberts & Co. (KKR), co-founded a Latin American private equity fund Pegasus Capital, worked at Boston Consulting Group, and served at Pace Industries (a KKR-sponsored leveraged buyout) as chief financial officer.

Yet, he has been drawn to microfinance through his life. He sees it as the one humanitarian effort that makes scale an ally. From 1993, the Chinese-born Uruguayan-American citizen was president and chief executive officer of non-profit microfinance organization Accion International for seven years. And in June, he started another fund—Ignia Fund—to invest in commercial enterprises in low-income markets of Latin America. He also lectures at HBS on leading social enterprise and doing business with the poor, and was in India earlier this month for research on Yes Bank Ltd’s “responsibility banking" for one of Harvard Business Review’s famous case studies—with particular interest in the bank’s partnership with Accion to do urban, individual lending. Chu spoke to Mint about why he is in India and why PE investors are now intrigued by this sector. Edited excerpts:

What interests you about Yes Bank?

I think it is important that Yes Bank has committed to go directly to microfinance and also actually integrate development banking. It is important considering Yes Bank is new. When you are a late entrant to an industry it is like being a young immigrant in a nation. You have to go in and say I take nothing of the status quo for granted.

What is the significance of Yes Bank partnering with Accion?

Responding to poverty and reaching very large numbers requires scaling up. For this, regulated financial institutions that can tap into the capital markets are needed. Now that the world accepts that there is an economic rationale to serve the poor and that it is attractive, then you have the opportunity of working with institutions such as Yes Bank and you don’t have to create a bank out of an NGO (non-governmental organization).

Customer focus: Michael Chu, Harvard Business School professor.

How is this partnership different?

Yes Bank and Accion look at the people they serve as clients. This is a broad generalization, but a lot of times NGOs look at the people they serve as beneficiaries. I think that is very important for product development to think of clients, because you think of customer service and try to understand their needs from their eyes.

What needs of the low-income sector are often missed?

You have to understand the cycle of cash generation of the people you serve. Also, when dealing with the over-banked segment, it is natural for the first topic to be the interest rate. But with low-income sectors, interest rate is only one part of the total cost of transaction.

The opportunity cost for the poor is huge, which is not intuitive. The interest rate could be nothing compared to what they could lose in a day’s business without the loan.

How do you view group versus individual lending?

You do group lending usually when you are breaking new ground in a market you don’t know anything about. So you rely on the due diligence being done by the people themselves. For example, in Bolivia, when no one knew anything about the market, the NGOs did group methodology. But when it became successful it changed the market for those who came later.

Why are PE investors interested in microfinance?

I would say that PE in general is just beginning to be interested in microfinance, although there were pioneering efforts by Accion and Profound in the 90s. I think that people are beginning to look at it with enormous interest now. In Europe and the US, so much money has been raised for PE purposes that it is very difficult, in my view, that this next cycle of investments can generate returns anywhere like the last cycle of investments unless people do something very different. And so PE in the US and Europe are hunting for alternatives.

Also, in Latin American, in April this year, Banco Compartamos in Mexico did an IPO that was extraordinarily successful. It was a secondary offering and 30% of Banco Compartamos was sold into the public. It was oversubscribed 13 times. On the first day of trading it went up 32%. Today the market cap of Banco Compartamos, which does nothing but microfinance and has about 700,000 clients and climbing very fast, is somewhere around $2.2 billion. That is an IRR (internal rate of return) of over 108 compounded annually . So of course it is attracting attention. And certainly it dwarfs any return I got at KKR.