In reaction to the financial crisis, the U.S. banking industry and its regulators have been forced to seek new consumer protections that will put the industry on stronger ground. In marked contrast, one global subsector of the financial industry is moving proactively to ensure that client protection remains at the core of its business model. That subsector is microfinance, the provision of loans and other financial services to the poor worldwide.
Over the past few years the world microfinance community of lenders, practitioners, investors and donors has engaged in a vigorous debate over how to cope with stresses induced first by a period of rapid growth and then by the world financial meltdown.
BuzzSome of those stress points have been reported in mainstream media. A recent front-page Wall Street Journal article focused on one Indian city, Ramanagaram, where an influx of several competing microfinance organizations (MFIs) has led some clients into over-indebtedness as they borrow from several competing institutions. From this local flare-up the Journal extrapolated, "A credit crisis is brewing in microfinance."
That broad generalization is unwarranted. With the exception of a few self-contained pockets, microfinance has held up relatively well through the financial crisis, notwithstanding a modest decline in the industry's historically high repayment rates and growth. Nonetheless, it is true as microfinance markets grow rapidly, MFIs need to ramp up their efforts to ensure that clients do not get in over their heads.
Most of today's large MFIs began life as virtually the only organizations interested in reaching their poor target population. They were therefore oriented toward growth. Now that they have not only grown, but also attracted new entrants, they must learn to manage competition--and avoid the temptation to over-sell in an environment in which their clients may seek loans from several institutions.
These new strains have added urgency to the debate within the industry about how to scale up outreach without losing focus on client protection. The problem is often oversimplified as a conflict between seeking profits, as most of the largest MFIs now do, and remaining true to the social mission. There is no evidence, however, that for-profit MFIs treat their clients any less responsibly than nonprofits. The truth is that microfinance can only achieve scale as a profitable business. But the viability of this double bottom line business very much depends on how well the industry treats its poor clients and balances the drive for profit with social objectives.
In May 2008 some 35 of the world's leading microfinance experts met at the Pocantico Conference Center outside New York City to hash out how the industry might balance the growth imperative with microfinance's social mission. The result, articulated in the Pocantico Declaration, was a resolve that the industry pool efforts to create collective standards that would institutionalize a commitment to serving customers' core needs.
Leading microfinance organizations, including umbrella groups, research organizations and investment funds as well as MFIs have since joined together to form a worldwide campaign for client protection in microfinance, dubbed The Smart Campaign, to stress that serving clients' needs in a sustainable way is a good business strategy.
First announced at the Clinton Global Initiative in September 2008, the Campaign seeks to unite microfinance providers worldwide to adhere to standards for the appropriate treatment of low-income clients. The Campaign commits signatories to ensure their adherence to six core principles: avoidance of over-indebtedness; transparent pricing; appropriate collections practices; ethical staff behavior; mechanisms for redress of grievances; and privacy of client data
To date, the Smart Campaign has some 850 signatories, including leading MFIs, social and institutional investors in microfinance as well as individuals working in the field. The goal is not only to expand the pool of committed MFIs and investors worldwide, but also to facilitate their implementation of the client protection principles throughout their operations.
The Smart Campaign is developing tools that will help MFIs maintain a rigorous focus on client welfare. The first is a Client Protection Self-Assessment that helps MFIs or their investors to determine how thoroughly an organization implements the six principles. For example, MFIs are asked to rate themselves on 10 practices that help prevent client over-indebtedness. These include 1) implementing a loan approval process that rigorously assesses the borrower's repayment ability according to measurable criteria; 2) using a credit registry when available, and seeking substitutes such as information-sharing with competitors when there is no registry; and 3) making sure that employee incentives only kick in for those who maintain high portfolio quality.
These kinds of tools are designed to create client protection standards that can take their place alongside financial accounting standards to create an accountability framework for financial institutions. Microfinance investors also have a crucial role to play; many are eager to incorporate assessment of MFIs' client protection practices into their due diligence.
Over the past three decades, microfinance has proved its counterintuitive case that the poor are bankable. Now the industry is again setting an example for the mainstream financial sector -- by committing to client protection and backing that commitment up with action.
About the Authors:
Elisabeth Rhyne is managing director of The Center for Financial Inclusion at ACCION International. Asad Mahmood is managing director of Global Social Investment Funds at Deutsche Bank ( DB - news - people ). Both authors are members of the Smart Campaign Steering Committee.