Archive for: Responsible finance in microfinance

Dear Sanjay,

Thanks for your thoughtful critique and ideas on how CGAP can best support the healthy growth of microfinance. We welcome your analysis of where the industry has come during a really exciting period in its development and growth. And we agree that we all need to do much more work to ensure that the 2.7 billion people still financially excluded today gain access to safe, reliable, and well-priced services that can help improve their families’ lives.

As we celebrate 15 years of CGAP, we are also reflecting upon where the industry has come, and where CGAP can be most useful in helping to advance financial access for the world’s poor. Like you, we believe that advancing financial access isn’t just about expanding access from a sheer numbers perspective—though that’s critical—it’s also about the quality of that access. This requires ensuring the establishment of healthy business practices, strong governance and oversight, and most important, developing products and services that meet the real needs of poor people, an area where the industry still sorely lags. On that last point, we have all learned a lot from the book published earlier this year, Portfolios of the Poor.

Your analysis of an industry that has become an “overcharged bull” is true of some markets. Indeed, we have written about the perils of unchecked growth, warning of the need to address core internal vulnerabilities within microfinance, and making recommendations on how to strengthen the industry. We also took a strong—and with some, unpopular—position on governance around the Compartamos  IPO. IPOs and 70-100% growth are the vivid symbols of rampant growth in pockets of India. But as a global organization, we are sharply aware that such buoyant growth is far from uniform. In still too many regions and markets, the opposite scenario prevails where access to financial services remains limited to a tiny percentage of the population. Even the global averages [23% growth in borrowers] mask what is really a very uneven picture.

CGAP’s messages have evolved as the industry and wider climate develops. We recognize that an approach that served the industry and its clients well at a time when it was in its infancy may not always hold today. We appreciate your generous recognition of the important role that CGAP has served for the industry in helping to establish consensus around some core principles and standards. We also believe that our founders were quite visionary in recognizing a need in the industry and in creating a global platform in CGAP through which debate could be had, and consensus reached.

CGAP continues to play an important role as a platform for a wide range of stakeholders to engage around standards, and agree on norms of practice. But the context in which we are working today has changed radically. And we must adapt.

Where the emphasis of our work in the early days was on establishing core standards of financial transparency and reporting, significant progress has been made and others continue to take that forward, so our emphasis today has shifted toward other areas needing attention, such as social performance reporting, consumer protection, and responsible finance. Some current work in this area includes the social performance reporting awards, developing consensus guidelines for MIVs that cover ESG, substantial policy work on consumer protection, and CGAP’s key role in the SMART campaign. None of this is a reversal from the achievements made on financial performance, but the rounding-out of those achievements to ensure that the industry best serves its mission to help poor clients. And we continue to support the MIX as a platform where institutions can report both financial—and increasingly social—performance in one place.

There are many useful insights in your analysis, though your interpretation of CGAP positions is not always accurate, or up-to-date. Even if “zero-tolerance-for-delinquency” language may once have been useful as a counterweight for a widespread lack of collection discipline, you are clearly correct that 100 percent on-time repayment is neither practically achievable nor even desirable in principle, most basically because it would imply exclusion of all clients who present any credit risk. CGAP did talk about zero tolerance in our early years, and will even plead guilty to having failed to nuance the concept adequately. But we’ve been clear for many years now that zero tolerance for delinquency is not feasible or appropriate. (And of the many MFIs we’ve recognized with grants and awards, we can’t remember one that ever had zero delinquency.) Or to take another example, our view about loan renegotiation has not been that it should never happen, but rather that it should not be used to avoid sound collection discipline or to conceal repayment problems.

We appreciate your acknowledgment of our work with mobile network operators and other new technologies, including G2P (government-to-people) payments, to promote financial inclusion. And it is also obvious that people living in extreme poverty need more than financial services: a whole range of interventions from livelihoods support to business development, education, health services, and even addiction counseling or other services related to the social issues that can be bred by poverty, are necessary. CGAP is committed to advocating for the needs of those living in extreme poverty.  Our work with “microfinance plus”, including the CGAP-Ford Foundation graduation program,  which now has 9 pilots active in 7 countries, has reinforced some key lessons: 1) the importance of savings; 2) people living below the poverty line need more than financial services; and  3) doing it well is hard. Any organization can claim to do all this, but each of the interventions mentioned above is a highly specialized business. Few organizations have the set of skills, or can even acquire the set of skills needed to provide such a complex set of services. Our experience with the CGAP-Ford Foundation graduation program has taught us that, often, quite an elaborate series of institutional partnerships and alliances are needed to deliver the right mix of services to very poor people. There are impressive organizations building businesses to address the range of needs they identify—a group of us recently had the privilege of visiting Jamii Bora which takes this approach in their work with slum dwellers in Nairobi—but in many more cases, partnerships will be critical to success.

In recent years and in some quarters the term “commercialization” has been used to denote greed, excessive profit, and uncontrolled growth—with all the negative consequences that entails for poor clients. Even though we have seen negative effects and excesses in some countries and institutions, we continue to believe that on balance the commercialization of microfinance has yielded great benefits for poor people. Overall, it has led to more professional, safe, and predictable services. It has resulted in the broadening of services beyond credit, most particularly the offering of safe savings services, and it has meant that many, many more people have access. The entry of socially responsible investors—still a much more prevalent source of funding than purely commercial investors—has opened up new opportunities for microfinance, and thus for poor people.

Clearly, cases of abuse need to be tackled, and tackled swiftly. There are refinements and improvements to practices needed, as well as greater transparency on all fronts. But we should be wary of chalking up every negative occurrence to a label of “commercialization”, and focus on the real challenges facing the industry. We need to reach agreement and develop practices around reasonable pricing and profits, governance, and what constitutes “responsible finance”—particularly getting a handle on the over-indebtedness of poor clients. At the same time, in many parts of the world the biggest challenge is not the excesses. It remains, quite simply, the basic challenge we’ve always had: reaching those who are still unserved, and developing the right kinds of knowledge and business models to do it well.

One of the hardest questions we ask ourselves constantly at CGAP is where we can add most value. We believe that our strengths as an organization lie in spotting and documenting trends, taking risks, and innovating so that successes can be taken forward by our members, partners, and others. Our best role is not so much in implementing models whose success is already proven, but in experimenting with unproven concepts, convening and sharing knowledge, helping to define standards and good practices in new areas, and advocating. As the microfinance landscape becomes ever more complex we, like so many other organizations in this field, constantly need to re-evaluate the focus and scope of our work and the technical skills and expertise needed to help us to achieve our mission.

And we do not undertake this reflection alone.  We hope that over the coming years CGAP will continue to be a key player in facilitating a more ambitious and expansive microfinance industry, with many new players and many new ways of working. But one thing is for sure: our mission is not one that can be achieved by any one organization. We fully believe that any advances will be made in partnership. So as we think about CGAP’s future role, and focus on where we can most add value, we’re also thinking about where we can work with others to achieve our shared vision of universal access to high-quality services that can help improve lives—something that people everywhere deserve.

With best wishes,
Alexia.

During the recent virtual conference on responsible finance several participants called on investors to reflect more on their growth expectations and insisted on proper assessments of governance, growth capacity of microfinance institutions, and debt saturation levels in the market. I agree. In my view, lending responsibly implies sticking to some of the basic principles of risk analysis and finance without letting competition for the best investment opportunities or fastest disbursements come in the way.

An overabundance of capital can trigger irresponsible actions or undue risk-taking on the part of investee companies. The experiences of countries like Morocco highlighted in a recent CGAP Focus Note tell the story. Investors were overeager to place funds in MFIs, which in turn grew too aggressively and were no longer able to manage their lending operations (i.e., they were less careful in the way that they placed loans). Disbursement pressure among investors comes from a large overhang of unplaced money sitting at microfinance investment funds. Beth Rhyne commented at the virtual conference that “this creates great pressure for investors to put money into MFIs that may not need it (or as much of it) or simply cannot manage it sustainably.” This does not mean that there is no need for investments in microfinance anymore. Rather, that investment funds are able to tap into new microfinance markets and investors are willing to take more risk to do so, as Blue Orchard commented in a recent post on this blog .

But the responsibility of investors goes beyond realistic growth expectations and accurate analysis. One other dimension that got attention in CGAP’s virtual conference, and rightly so, is the return expectations from investors.

Gil Lacson, of Womens World Banking, asked what a “reasonable” financial return would be for an investor, or an “acceptable” level of profit for the microfinance institution,  given that the customers of microfinance are the poor and disadvantaged. This brings us to the realm of business ethics in microfinance: how much money should an investor and the MFI make?; what is obscene (or too much) and what is appropriate?; and who should pass that moral judgment?

Should others follow the example of the founder of India’s Equitas Microfinance institution that abides by a policy that voluntarily limits its annual Return on Equity? And if so, is Equitas’ voluntary limit of 25% a reasonable one?

As an example of how investors are addressing this question, KfW looks for a “risk constellation”, by examining the correlation of high average return on equity, high interest rates, high level (also in absolute terms) of nonperforming loans/losses, and a low level of loan loss reserves. KfW’s checklist  for its investment officers suggests that a constellation with a return on equity greater than 25%, a portfolio at risk (30 days) greater than 10%, interest rates greater than 40%, and insignificant levels of loss reserves (occurring together) gives a first hint of irresponsible lending practices.

We are only at the beginning of this debate. The responsibilities and expectations of microfinance investors and managers are coming under increased scrutiny.  What metrics to use to measure responsible investment and, more important, how to determine what standards are acceptable, will be key questions to address in the coming months. Watch this space.

Once a year, CGAP’s membership and governance body, the Council of Governors, meets to set CGAP’s broad policies and strategic directions, provide inputs to our annual workplan and budget, and debrief one another on the latest trends in financial inclusion. That meeting is underway this week in Nairobi, Kenya. In addition to a special focus on microfinance in Africa and branchless banking, we’re hearing the latest thinking around responsible finance.

Earlier this week, New York Times columnist Tom Friedman suggested that the increasing interconnectedness of the economic, financial and environmental crises points to the need for new perspectives on ethics:

…in a world where our demand for Chinese-made sneakers produces pollution that melts South America’s glaciers, in a world where Greek tax-evasion can weaken the euro, threaten the stability of Spanish banks and tank the Dow, our values and ethical systems eventually have to be harmonized as much as our markets. To put it differently, as it becomes harder to shield yourself from the other guy’s irresponsibility, both he and you had better become more responsible.

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CGAP has been hosting a two-day online Virtual Conference “Responsible Finance: Making it Work in Microfinance” on April 12-13. The event is bringing together MFIs, policymakers, NGOs and individuals from across the world for a rapid-fire online debate and discussion.

Day one of the conference focused around the question “what is responsible finance, and why is it needed?” and featured guest moderators from four continents and nearly 300 participants commenting and following along with the debate. Hot topics of discussion included:

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