Is it responsible when a financial co-operative tells its clients that their loan’s interest rate is “only 3%” (without mentioning that this price is per month, is calculated on a flat basis, and excludes the fees and a premium for high-priced credit life insurance)? How about when “dormancy fees” erode a depositor’s account balance every month? What if a microfinance institution’s (MFI’s) brochure claims that it serves the poor but it fails to analyze the poverty status of its actual clients or offer services well-tailored to lower-income people?
The answer to all these questions is obviously “no!” A sector built on the idea that benefiting unserved or underserved clients through access to quality financial services, married with a financial commitment to operating profitably so access to services can be sustained over time and offered to growing numbers of clients, needs to pay particular attention to its responsibilities to clients, especially because those clients are potentially vulnerable.
Many microfinance providers and other industry stakeholders are focusing more on the need to deliver services that are safe, offer good value for money, and are likely to generate benefits for poor clients. Three main strategies can help advance responsible finance. The first is consumer protection regulation and supervision, where financial authorities set and enforce rules to ensure that retail services are offered transparently, that providers treat customers fairly and do not put them at risk from harm such as over-indebtedness, and that effective mechanisms exist to address customer complaints. The second responsible finance strategy is action by the industry itself to improve its own behavior and services, such as standards and codes of conduct. And the third strategy, which includes interventions that raise consumers’ awareness and strengthen their financial capability, helps customers behave responsibly and protect themselves from harm.
For the retail providers with a development mission such as serving the poor, responsible finance has two dimensions: client protection and social performance management. The do-no-harm mandate of client protection extends to all providers of financial services to lower-income and otherwise vulnerable consumers, including those who may not have a social mission focused on financial inclusion. However for purely profit-motivated providers, regulation might be the most practical solution to achieving client protection. The second dimension – social performance management—applies to those institutions that profess to have a double bottom line (which includes the great majority of microfinance providers, funders, and support organizations). It is reasonable to expect these institutions to operationalize their mission into specific social or development metrics, assess their performance against those metrics, and adjust their strategies and services accordingly. While missions may vary, the most common social goals are outreach to underserved people, poverty reduction, and empowerment of women. As double or triple bottom line institutions, most microfinance players are also expected to demonstrate progressive practices towards their employees and the communities they serve.
The responsible finance movement in the microfinance sector consists of a series of well-coordinated initiatives to enhance client protection, strengthen social performance management, and define acceptable behavior for microfinance investors and donors. The most important of these are the Smart Campaign (which has mobilized almost 1000 retail providers, dozens of networks and associations, and well over 100 funders to improve products and practices) and the Social Performance Task Force (which has just launched industry-consensus standards on social performance management).
Microfinance funders play a critical role in creating incentives for and supporting responsible practice by MFIs. Thus, initiatives have also emerged to hold funders more accountable for how they treat their partners and how they define and measure their own double or triple bottom lines. Most important are expectations that funders build responsible finance considerations into their own due diligence, partner selection, monitoring, and performance reporting processes. More than 50 investors have signed the Principles for Investors in Inclusive Finance to express their commitment to do so. Grants and technical assistance can also finance improved retail-level practices and products, consumer protection regulation and supervision, and consumer financial capability.
These initiatives are forcing the debate on the next generation of tough issues for microfinance, including:
- Making products and business models more responsible: Most energy so far has rightly focused on ensuring that microcredit services are safe and delivered appropriately. Indeed, many challenges remain in evolving typical individual and group lending models to meet current client protection standards. At the same time, we need to analyze gaps in other services (deposits, payments, insurance) and how innovations such as branchless banking can be delivered responsibly.
- Balancing client vs. provider vs. investor interests: Now that most industry stakeholders have acknowledged that microfinance involves some trade-offs, at least in the shorter term, the sector has begun to explore the specifics, such as limits on sustainable growth or pay-offs over time from staff training and improved social performance management systems. Another key question is whether customers will reward more responsible players with their trust, loyalty, and willingness to take up more services. The conversation on financial returns is also getting deeper: how much profit is too much? Should providers be expected to pass on most efficiency gains to customers as lower prices or better quality services? Are some investors squeezing MFIs with excessive prices, onerous financing terms, and unreasonable targets for return on equity? Do some MFI managers get too much compensation?
- Moving from social performance process metrics to measuring client outcomes: A recent survey of 405 providers (MBB, July 2011) documented weaknesses in monitoring and reporting on client outcome indicators. For example, few providers do serious measurement of client poverty status and the variety of indicators and tools makes the data difficult to benchmark. Assessing whether microfinance clients move out of poverty on any systematic basis is still more difficult. While many providers cite generating employment and supporting business creation as development goals, these types of outcomes are not commonly tracked.
Topic Contact: Kate McKee
- World Bank Responsible Finance web portal
- Defining responsible financial performance: how to think about growth (MIX)
- Defining responsible financial performance: the role of profits (MIX)
- Defining responsible financial performance: understanding efficiency (MIX)
- Defining responsible financial performance: how to think about social performance (MIX)
- Implementing Client Protection in Microfinance: State of the Practice, 2011 (Smart Campaign)
- Smart Campaign Comprehensive List of Tools and Resources (Smart Campaign)
- A survey of 405 MFIs reporting to MIX in 2009–2010 (MIX)