Recalibrating Microfinance: A Six-Point Program

December 21, 2010

This is a guest post from Elisabeth Rhyne, managing director of the Center for Financial Inclusion at Accion International, based on her presentation at this month’s public discussion of the global implications of the microcredit crisis in India.

In a private email a couple of weeks ago, David Roodman challenged a few of his contacts in the microfinance sector. He wrote, “Commercial microfinance is under attack in way that it has not been for a long time. Milford Bateman has published his book arguing that it is doomed by its very nature. Yunus is publicly chastising investor-owned MFIs and pinning blame for the ‘wrong turn’ toward investor-owned MFIs on the ‘World Bank.’ And there is the debacle in India.”

As usual, David is right. The current crisis in microfinance in Andhra Pradesh is the most serious challenge to the microfinance sector in its brief history. In the wake of the crisis, calls are arising to “recalibrate” microfinance, or, as Vijay Mahajan put it, to “get the house in order.” While the origins of the crisis are complex, and many of them are India- and AP-specific, the crisis reveals shortcomings in microfinance that urgently need to be addressed.

This recalibration needs to be as vigorous as we can possibly make it. As I think about past crises—in Bolivia, Nicaragua, and in AP in 2006, I am struck by the sluggishness of the response by the industry. Those in the thick of the crisis learned some lessons—the hard way—but the rest of the industry has tended to shrug it off as someone else’s problem. Complacency rules, as it does in most things where human beings are involved. Compare this to the world response to climate change—some responses, but nothing like what is needed. Al Gore’s charge has been: WAKE UP! And that is my call to microfinance. Because microfinance is a much smaller arena than global climate change, we have a more manageable set of tasks.

Herewith, a Six-Point Action Agenda.

1. Get serious about Client Protection. We started working on what is now the Smart Campaign two years ago. When I look back, I see that we have made enormous progress. The microfinance community has come together around a set of six Client Protection Principles. These principles are widely known and accepted. At first, we often heard MFI leaders say “We don’t need to work on client protection because we’re already doing a good job” or “We aren’t convinced of the business case for client protection.” No one says that today. But there is still a long way to go before client protection practices are robust enough to prevent future problems in avoiding over-indebtedness (Principle 1) or increasing pricing transparency (Principle 2).
2. Get serious about Governance. The AP crisis has tagged “founder domination,” executive compensation and the role of pure-commercial private equity as issues needing attention. The Council of Microfinance Equity Funds has issued governance guidelines that are widely used, but in governance one can easily fill the letter without the spirit: the spirit of good governance goes well beyond whether there is an audit committee or independent directors. Progress on this front requires a lot of open dialogue about the “real” problems – like aligning the personal interests of stakeholders with those of the institution. Social investors play a central role here; they could seriously step up their commitment to good governance.
3. Truly embrace Savings. Credit-only organizations are prone to over-lending because it’s their only link with clients. If a client repays all loans, she’s no longer a client. Financial institutions that offer savings and credit have a healthier client relationship, and there are fewer examples of unrestrained growth among deposit-taking institutions. It seems likely that clients with savings are less prone to get into debt stress (though this hypothesis should be tested by new research). We’ve seen that it is very hard for institutions that start as credit-only to morph into balanced savings-credit institutions. But this transition is necessary. Regulators play an important role here to create viable regulatory pathways.
4. Build Credit Bureaus. The microfinance industry has been slow to embrace credit bureaus, and some of the credit bureau development projects around the world have been focused more on the mainstream financial sector, omitting microfinance institutions. This needs to become a major priority with expanded funding from donors.
5. Learn more about Debt Stress. We know very little about how clients get into debt stress, how over-indebtedness and multiple indebtedness are connected, and what happens to clients once they become over-indebted. I know of only one or two studies completed to date. If we are to avoid harming clients, we need a much more solid information base for constructing policy.
6. Create Fair-Trade Microfinance. It is high time for the launch of “Fair Trade Microfinance.” The broader world, including international media, investors and donors, will only have confidence in microfinance if the industry can in turn provide confidence that its members are genuinely working on behalf of their clients. This kind of confidence ultimately needs to extend to the clients of microfinance, too. Efforts to create forms of certification are starting. In fact, the Smart Campaign’s task force on certification met this morning and laid out a way forward. Successful branding of fair-trade microfinance will require intensive work and cooperation among all major microfinance industry players.

Recalibrating microfinance requires everyone to step up their commitment to improve their own practices and to cooperate across the industry to put protections into place. The good news is that the microfinance sector is made up of actors whose social motivation is genuine and deep. If the whole sector can wake up to the needs outlined here, I have no doubt that we can set microfinance on a sound path for the future.

Possibly Related Posts

• Backgrounder on India’s Microfinance Crisis
• They Told You So
• Rare Canvassing of Client Voices in India

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1. Eric Says:
   December 22nd, 2010 at 11:33 am

   Now that the term “microfinance” is used so broadly by so many different institutions, it is necessary to decide what it is, and whether there are substantively different categories within “microfinance” that should be analyzed separately from one another. I would propose the following taxonomy:

   1. For-profit microfinance – This refers to investor-owned MFIs and banks that see microfinance as a source of increased profits. By their nature, these institutions will tend toward overindebtedness and a lack of client protections.

   2. Grameen-style microfinance as a complex social interaction – This is, obviously, what Prof. Yunus pioneered, where the financial transaction is simply the entry point to a process of social capital building and individual transformation.

   3. “Fair trade” microfinance – I think Ms. Rhyne is correct in proposing “fair trade” microfinance, which offers a “middle path” between for-profit and Grameen-style microfinance. This is where certifications and even government regulation will become important to make sure a balance is kept between financial return and social impact.

   The current crisis in microfinance stems from a reluctance on the part of MFI’s in the 2nd category to declare that they are in fact different from institutions in the 1st category. Is anyone under the impression that the social aspects of Grameen microfinance, such as mutual accountability and the “Sixteen Decisions,” are completely insignificant to the outcomes that clients experience? If they are significant, then doesn’t that warrant explicitly distinguishing this form of microfinance from other, purely financial forms? Why do the people in category #2 assume that everyone using the term “microfinance” is on the same team?

2. tom sanderson Says:
   December 22nd, 2010 at 1:11 pm

   Elisabeth,
   Thank you – this is a great article, and I fully support your remarks.

   Tom Sanderson
   UK Director
   Five Talents

3. Beth Rhyne Says:
   December 22nd, 2010 at 7:30 pm

   Responding to Eric’s comment:
   The real world is awash in mixed motives and methods, and it is not so easy to divide microfinance into two neat groups. Most commercial players have social motivations and most socially motivated players are trying to be sustainable and raise money commercially. What clients receive is also a spectrum of services that are better and worse on various dimensions (mix and match from some of these categories: convenience, dignity of treatment, non-financial services, affordability, product flexibility and fit….). Not so easy to say who belongs in which bucket. I have always been in favor of microfinance pitching a rather big tent and ensuring that everyone in it pursues social goals seriously, and uses business principles to make it work.

4. N.Srinivasan Says:
   December 26th, 2010 at 1:20 pm

   I agree with all but one of Beth’s agenda. I am not sure that credit information bureaus deliver much of value in imperfect markets that are fragmented and where informal and semi-formal lenders continue to be active. In the Indian context, credit bureaus have quite some distance to travel before they become useful in any manner to MFIs. To avoid multiple lending is not a virtue. Avoiding excessive debt is a desirable objective. This is achieved by better quality customer appraisals. A credit bureau does not interact with the customer household the way a field officer does.
   Let us invest in good quality customer appraisals and invest time and effort in designing good appraisal and customer interface processes that would secure interests of both borrower and lender.
   N.Srinivasan

5. Guillermo Bolaños Says:
   January 27th, 2011 at 12:30 pm

   As with the U.S. and European banking crises, the Nicaraguan MFI debacle has much to do with lack of prudent credit principles: ability to pay (one of the 5 Cs of credit) was predicated on speculation by lenders. Short term loans at high interest rates for agriculture and cattle producers were impossible to repay once meat and agricultural product prices stopped growing as fast.