May 1, 2011 | by
Early microfinance pioneers created the sector with the aspiration to improve poor people’s lives. There were huge swathes of “white space” where low-income households had little or no access to formal finance. This challenge, in turn, demanded sustainable and scalable models for delivering adequate financial services to poor people.
This is the essence of the double bottom line in microfinance: a social commitment to benefiting clients married with a financial commitment to operating profitably. In the long run, these two objectives do not contradict each other: doing right by all stakeholders is the only long-term sustainable business solution. Over time, the market should reward retail providers that adequately protect clients’ interests, affirmatively treat them well, offer a product line responsive to their needs, and deliver good value for money. In the short run, however, tensions can arise.
Tensions are evident in the microfinance sector— in the recent repayment crises, local microcredit markets suffered from overly rapid growth, resulting in loss of credit discipline, multiple lending, and instances of over-indebtedness. There were powerful social and financial reasons to scale up quickly, and investors were eager to back this rapid expansion. In retrospect, however, we see that lenders in these markets—and indeed in the microfinance field as a whole—may have overestimated the demand for credit. Saturation occurred more quickly than expected, particularly since microcredit institutions often competed for market share in the same client segments and areas rather than reaching out to less served areas. Internal systems, including controls and staff development, failed to keep pace with growth. Regulation did not permit these nonbank providers to offer other services, such as deposits, that would have improved both the customer value proposition and provider risk management. Other mechanisms that could have helped manage the growing risks, such as effective credit information sharing systems, were not in place.
The credit crises brought into focus the shortterm trade-offs that may exist among the quantity, quality, diversity, and reach of financial services delivery. We need to better manage the tradeoffs to ensure that products and practices are sound and client welfare and institutional viability are not put at risk. Scale and sustainability goals remain legitimate and, indeed, critical goals, but they must be supported with the necessary infrastructure, such as credit bureaus, and public goods, such as transparency regulation. In sum, we need to rebalance the double bottom line as our collective goal shifts from simply filling in the white space to developing a healthy and responsible market.
Against this backdrop of high aspiration and new challenges, the microfinance field has embraced the need for a proactive responsible finance agenda and accelerated its efforts to implement meaningful improvements in products and practices. There is a growing consensus that providers of financial services to the poor must adhere to a standard of care that minimizes risks for their customers, who typically have low and variable incomes, little margin for error in financial decision making, and limited formal education and exposure to formal finance.
In this paper, we define what we mean by responsible finance, both as an end-state vision and in terms of a pragmatic focus on client protection and social performance management to help achieve our goal. This paper explores the state of responsible finance knowledge and practice, with a focus on three mutually reinforcing client protection strategies:
It also examines emerging practice to support the basic premise of social performance management— that business processes must be aligned with mission and, ultimately, deliver on the promise of client benefit. It then describes funder roles in promoting responsible finance and closes with observations about future implementation challenges.
Categories: Financial Services Standards