As mainstream credit markets seize up, the world's microfinance organizations, or MFIs, have not yet felt much heat. If anything, the crisis of confidence has highlighted what a good credit risk most microfinance clients have proven to be.
Isolated in most cases from their countries' formal economies, the self-employed poor are also resilient during downturns. Indeed, microfinance may be a bright spot in the banking industry's future — a huge market of hundreds of millions, whom pioneering microfinance specialists are learning to serve in a sustainable way.
But the credit crisis highlights a threat of another kind. The subprime lending abuses that fueled the U.S. housing bubble demonstrate the dangers of financial services to the poor done wrongly. The subprime industry's core failures in consumer protection — tempting low-knowledge customers into overindebtedness, ignoring capacity to repay when approving loans, failing to clearly disclose and explain loan terms — are the fruits of intense competition and ineffectual regulation. Though these practices are not widespread in microfinance, competitive conditions in some markets could tempt providers to adopt some of them.
In some micofinance markets, client overindebtedness is becoming a real danger as conventional banks and retailers pile in to offer consumer credit alongside the business loans that are MFIs' staple. Transparency is a constant challenge when working with a client base that is often illiterate. Privacy and security are emerging issues as innovators press forward with technologies such as transactions via cell phone.
As microfinance has grown rapidly in the past two years, tensions have grown within the world community of providers, which range from tiny nonprofits to publicly traded financial institutions. At issue is how to balance two imperatives: widening access to financial services and maintaining a vigilant focus on the welfare of poor, often illiterate, clients.
Microfinance is becoming an industry increasingly run on commercial principles and fueled by commercial investors. Investment in microfinance funds grew at a compound annual rate of 80% from 2004 to 2007, according to the Consultative Group to Assist the Poor, and now stands at $5.4 billion. The challenge is to ensconce a social mission and commitment to clients' welfare within the fabric of micofinance organizations that are operating as profit-seeking financial institutions.
At the Clinton Global Initiative last month, a consortium of some of the world's leading microfinance organizations announced a joint effort to focus their industry on securing fair treatment for clients. The Campaign for Client Protection in Microfinance aims to achieve industrywide commitment to six core client protection principles, codified in a microbanker's oath.
These principles include ensuring that microfinance institutions do not engage in reckless or predatory lending; that they are transparent with clients about prices, fees, and terms; that they treat clients with dignity even during debt collection; and that they keep client data secure.
A goal of the campaign is to engage within three years at least half the world's 500 largest MFIs that report to the MIX Market, an industry clearinghouse. The MIX 500 MFIs serve an estimated 65 million borrowers among the self-employed worldwide.
The consortium said it envisions that tens of thousands of people working in the microfinance industry will personally sign the oath. As important, they will develop implementation guidelines and promote certification standards to ensure compliance with the core principles. The aim is to encode consumer protection practices and principles in the permanent DNA of the microfinance community.
The campaign is not intended to be a substitute for government regulation. Indeed, in many developing countries, it may serve as a template for effective regulation. And we believe that the campaign can pioneer strong norms and practices industrywide. By creating true benchmarks and assessment procedures for client service, it could become a way to brand verifiable excellence in responsible finance.
Microfinance has defied conventional wisdom by proving that the world's poor are bankable — and that financial services outreach to the poor is scalable. The next wave of microfinance innovation must be to make the double bottom line a reality — to show that social mission and profit can be fully compatible.