Can Self-Regulation Protect Microfinance Clients?

Last month the Smart Campaign launched its certification program, For those who care about client protection, this is an important and welcome milestone in what has been an impressive journey, which has included a broad spectrum of activities by funders to promote client protection. 

In the first post in this series, Philippe Serres describes a project by the French development organization AFD and the Cambodian Microfinance Association (CMA) to support implementation of the Client Protection Principles, including support for MFIs seeking to undergo the Smart Certification process itself.  Notably, this support comes alongside client protection requirements that funders like AFD, Proparco and FMO have been incorporating into their financing agreements with MFIs.  Thus, not only are MFIs being supported in their bid to strengthen client protection, they are increasingly required to do so by their funders. 

In many respects, this is an exercise in self-regulation of client protection practices.  The arrival of Smart Certification presents a unique opportunity to take these efforts to the next level and apply this self-regulation to the entire microfinance market in Cambodia and beyond. 

Effective self-regulation rests on two key components:  a transparent and consistent standard to measure compliance and a credible mechanism to insure that it can be enforced.  Smart Certification provides that standard.  What could provide its enforcement?

Some may ask - is enforcement necessary?  Several MFIs in Bosnia and India have already become Smart Certified, and one can expect quite a few others to follow suit in the coming months.  Is not the positive brand image of being Smart Certified sufficient to create its own momentum? 

I don't believe so.  The trouble is that some of the most important Principles of Client Protection, including prevention of over-indebtedness, require a coordinated approach in order to be effective. Experience has shown that, when left unconstrained, aggressive lenders can – and do – reap the benefits of their destructive practices, while spreading risk across the entire industry.  It matters little whether a client's 1st and 2nd lenders are responsible.  What drives over-indebtedness is that other lenders are willing to provide her with the 3rd or 4th loan, and beyond.  This places the original lenders in an impossible position of either having to walk away from their established clients or keeping them only at the cost of undermining their commitment to avoid over-indebtedness.  

The requirements that AFD, Proparco and FMO have incorporated into their financing agreements with MFIs in Cambodia show a plausible path.  But what if these requirements went further, by making funding conditional on Smart Certification and bringing all major MFIs under that rubric? The power of the funders is considerable:  92% of borrowings of the 8 largest Cambodian MFIs come from the broad spectrum of social and development investors that can be considered part of the microfinance investment community (Figure 1), nearly all of whom have endorsed the Smart Campaign.  Meanwhile, the largest five of these funders account for a third of all MFI debt funding. 

The leading investors also share something in common – most are Development Finance Institutions (DFIs), whose impact is magnified further still through their funding of Microfinance Investment Vehicles (MIVs). And a similar pattern holds for equity investments. Indeed, in a country like Cambodia, few if any leading MFIs can claim to be independent of DFI funding.

Their role as funding leaders puts the DFIs in a perfect position to kick-start enforcement of client protection by mandating that MFIs become Smart Certified as a precondition for investment.  Because MFIs maintain multiple funding relationships, the impact of such a mandate would quickly propagate through the market (Figure 2).  After all, it does not matter who mandates the certification – it would redound to all of the certified MFI’s investors.  As a result, as a critical mass of MFIs become Smart Certified through the mandate, even MIVs that receive no DFI funds would see many of their investees in the country becoming certified. 

Reaching critical mass of certified MFIs would have two important outcomes:  first, it would isolate the few remaining large MFIs unaffected by the mandate, at which point it's likely that they would choose to become Smart Certified rather than risk being singled out in front of their regulators, politicians, and the local media.  Second, as the mandate is rolled out across more countries, the same dynamic would emerge among funders and investors, whose portfolios would become increasingly populated by Smart Certified MFIs.  At that point, it's likely that investors would themselves start to apply the mandate rather than be singled out for having lower rates of Smart Certification than their competitors.  In effect, by kick-starting the process, the original mandate could credibly push the microfinance sector from an equilibrium where Smart Certification is regarded as desirable but optional, to one where it is seen as required.

Of course, when considering mandating Smart Certification, it's critical to apply it carefully and avoid unwanted side effects.  Given the complexity of the process, it's unrealistic and unreasonable to expect young or small MFIs to become Smart Certified, and in any case, certification of thousands of MFIs is difficult to achieve in practice.  But it's also not necessary.   In Cambodia, there are 32 licensed MFIs, but the largest 8 MFIs account for 91% of total clients in the country, according to MIX Market.  This is consistent with most countries, where 80% of the microfinance market is split between four MFIs or fewer (Figure 3). 

This market share of 80% is a reasonable target for achieving the necessary critical mass.  A sensible approach would be to set the target at a specific size to hit this threshold – in Cambodia, this amounts to assets of $40 million or 90,000 borrowers.  At the same time, the threshold doesn't mean a free pass for smaller MFIs, but instead provides an incentive to include Smart Certification into their growth plans, since they too would fall under the mandate once they hit that threshold.

Finally, because the mandate would target leading MFIs, it would mostly apply to large institutions that should generally be able to afford the cost of Smart Certification and the sometimes costly changes it may entail.  The few smaller MFIs that still fall within the mandate may need some amount of subsidy, perhaps along the lines of the Rating Fund, though the total sum required is likely to be modest.    

AFD, Proparco and FMO have essentially already begun this process in Cambodia.  What remains is to formalize those requirements to include Smart Certification, set the institutional size at which the mandate would be applied, along with a timeline by which Certification would have to be completed.

Meanwhile, their provision of funding and technical support to help implement client protection will help smooth the path towards Certification.  With this approach, Cambodia could well become the first country where all leading MFIs become Smart Certified and thus set the standard for others to follow.


----- The author is an independent microfinance consultant based in Brussels, Belgium.



07 February 2013 Submitted by Hugh Sinclair (not verified)

An excellent article. Indeed, the parallels to the historic rise of the MFI (regular) rating are visible, although mandating this goes one step further. Reaching critical mass is key, and the Rating Fund certainly helped in this regard. Another fringe benefit, perhaps overlooked, is that this enables the DFIs, and possibly the MIVs, to wash their hands somewhat. They can demonstrate that they undertook objective, independently managed steps to ensure the integrity of their investments. When things go wrong, they have a line of defense. However, I see two main problems here.

Firstly, this provides no direct comfort to investors that the MIVs are behaving appropriately, and as recent media attention has highlighted, there are valid reasons to suppose some form of regualtion or rating of MIVs themselves is required. Sure, the investors in an MIV can investigate whether the MIV is investing in certified MFIs, but are all investors so astute, or even aware of this? Also, to what extent will lazy MIVs accept certification in place of valid due diligence? However, this is a lesser concern here.

Of greater concern is that we are placing a lot of trust, indeed, inordinate control over the flow of funds, into the hands of a structure designed and monitored, if not implemented, by Smart. I have a number of concerns regarding the Smart Campaign which I shall not re-iterate here. But consider two simple flaws with Smart.

Who defines "affordable" interest rates? Extortionate interest rates are a hot topic, but the sector has been slow to define extortion. Smart claims to promote affordable credit. We need very clear details on how this is assessed. I focus on this single variable as it is concise and comprehensible to everyone, but likewise with "appropriate" products, "adecuate" care, transparent information should be "highlighted", "respectful" treatment of clients etc. Who defines these terms? Credibility of the certification will arise from firm definitions, and consequences for those who breach them. Any incentive system requires sticks as well as carrots. The current policy of Smart endorsement without enforcement is correspondingly meaningless, and the Seal is a step in the right direction, if done objectively, transparently, rigorously and with clear interpretation of the results.

My second concern regards the broader credibility of the organisation. The IPO of Compartamos, the Mexican bank charging rates up to 195% while yielding vast profits for Accion and other shareholders and individuals, divided the microfinance community. Many perceive them, correctly in my opinion, as vultures, profiteers, pioneers of the mass exploitation of the poor, symbolic of much of what is wrong in microfinance, and these sentiments have been echoed throughout the sector up to Yunus himself. If I may quote transparency veteran Chuck Waterfield in this regard, from the recent KRO-Reporter documentary:

"Some of what is happening in microfinance right now is a transfer of wealth, not the old-school ‘help the poor’ send money down to the bottom of the pyramid. We see a transfer of wealth from the bottom of the pyramid up to the very very top 1% of the pyramid. The rich getting richer off the very poorest in the world.”

For as long as the Smart Campaign is financed and housed by Accion, staffed by ex-Accion employees, and fails to address the issue of extortionate interest rates (as well as other issues such as child labour in micro-enterprises), it simply has limited credibility. Smart are quick to advise the sector on how to protect clients with affordable credit, but slow to comment on the rates charged by the likes of Compartamos. Accion recently acquired CrediConfia, lambasted in the Mexican media for charging up to 229% per year. The irony that Smart is indirectly funded by such exploitation is obvious.

Can we take this institution seriously to protect the interests of the poor?

Thus while I applaud this step in the right direction, and largely agree with the idea of mandatory certification, particularly for public funding, the weak link in the chain may be the integrity and management of the Smart Campaign itself. I would far rather see an independent body without direct links to institutions such as Accion (of all players), managed by similarly independent staff, with clear definitions to the array of nice-sounding nebulous terms, armed with sticks as well as carrots, and prepared to stand up publicly to the vultures in the sector which tarnish us all with a bad name.

07 February 2013 Submitted by Dr.V.Rengarajan (not verified)

Four concerns on CPP
Certification mandatory is welcome and of curse creates awarness on CPP.However four concerns
First, like mere finanail inclusion, is mere mandatory sufficient for causal claims with indented consequences in the context of multiple actors in the supply front including tech service providers in terms of accountability?
Second, while MF by definition includes many pro poor micro services like micor insurance , micor savings, why does smart CPP confine to micro credit service providers only ? Does present focus on micro credit delivery warrent priority status for provision of CPP only for borrowers only?
Third, in the case of graduation projects for the bottom poor (like CGAP - BRAC Model) micro credit is not used till they are graduated . Are they also eligible for smart CPP? Are'nt these vulnerable people merit priority in this regard (CPP)
Last, does CPP cover only the exisitibg clinets or cover drop out clinets also?
Dr Rengarajan

07 February 2013 Submitted by Getaneh Gobezie (not verified)

Dear Daniel Rozas,

Thank you for this excellent analysis.

I also strobgly believe that self regulation has little chance to work on the ground. There need to be someone to do over-all supervision of microfinance operation like the Smart Campaign. At least such bodies can guide on internationally accepted 'norms' of client protection. Microfinance service providers, left by themselves, often lack knowledge of such norms; or even when they have such knowledge, they may not be fully commited to pursue such objectives in their day to day operations -- especially more so if they are operating in less competitive atmosphere where clients have little choice of service providers. This is really true in many African countries. ... In many cases, only a handfull of microfinance institutions supply 80-90% of the available services. So positively influencing these few can set an example for other small and/or new comer suppliers.

So we can NOT rely upon self regulation of service providers... We have already seen some real cases -- like in extreme cases of India, Andhra Pradesh quite recently. ... From our [MFP] microfinance yahoo group discussion on the Andhra Pradesh case, I am always reminded of a husband os a client who commited suicide --

The husband of the woman who committed suicide (because of repayment problem, and bad collection practices) is explaining how the MFI staff treated him self and other family members afterwards:

Client E’s Husband: “Some collection agents were really rude-after my wife committed suicide.” They came and said, “If you cannot find means to repay, then you should send out your two beautiful daughters, and get them to earn money by other means (prostitution…) and then repay to us.” One of them even said, “If you cannot do that, send them to me and I will use them and pay off your installments. They are very beautiful and would be able to earn a lot. ..... I wept as I heard this…”

I hope those of us working in the sector would not be hearing this kind of cases in the future.

Thank you and Kind Regards

Getaneh Gobezie
Gender and Ruralfinance consultant

08 February 2013 Submitted by suran (not verified)

Thanks for the article; you have hit the nail on the head. “Enforcement is the key”, but will SRO enforce? Do ratings or seal of excellence etc help? Not at all sure.. Remember all the institutions we had in AP where are all independently rated by professional rating institutions! nobody mentioned the risk of overcrowding cheers, suran

19 February 2013 Submitted by David Roodman (not verified)

Daniel, I think this is a creative idea, so I'm glad you've made the case for it. My main concern about it is whether the funders will have the capacity to monitor "responsibility" and have the will to withhold funds when conditions are not met in spirit. The history of structural adjustment--a huge effort to influence the behavior of governments by placing conditions on loans to them--suggests that this will not be easy. I elaborate on these ideas in a post I did last December (…).

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