Recalibrating Microfinance: A Six-Point Program

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.