Responsible Finance

July 15, 2008    

As the visibility of microfinance has intensified, so has the scrutiny. Microfinance has been made popular in large part by the promise of doing well by doing good. Attention is being focused on how to ensure that access to finance results in benefits for clients. A lively and important debate on the principles and practices of “responsible finance” is buzzing across the field.

CGAP is engaging investors and policy makers so they are better equipped to reinforce emerging efforts by microfinance providers to protect client interests.

Why now?

Proliferating commercial players
The entry of new finance providers into the traditional microfinance market – consumer lenders, retailers, commercial banks, telecom operators – raises the stakes for clarifying responsible principles and practices for serving base-of-pyramid consumers.

Dramatic growth in investors and investment
At the same time, the interest of investors in the sector has exploded, making the responsible finance conversation for our field still more urgent as they seek to assess both risk and social value.

The policy balancing act: Access vs. protection
As financial inclusion becomes a hot item on the policy agenda in many parts of the world, so too does the worry that vulnerable clients may need protection from unscrupulous providers and unsuitable products. And branchless banking models, with new technologies and nonbank agents, raise tricky protection challenges. Yet, if taken too far, the legitimate protection concern of policy makers can end up harming those without access to formal finance. Heavy-handed regulation in response to hot-button issues like client over-indebtedness or “excessive” interest rates – such as imposing interest rate caps or dictating loan terms – could limit legitimate finance for the poor.

Taking action

“The time is ripe to address the issue of responsible finance proactively, creatively, and vigorously,” says Kate McKee, CGAP consumer protection expert. “Getting out ahead of the curve is not only the right thing to do for our clients – it helps maintain the confidence and trust of the general public; gives the wave of new investors confidence in the field; and ensures that politicians and regulators do not impose solutions that go too far and reduce access.”

For its part, CGAP’s new strategy seeks to raise awareness with providers, investors, and funders about practices that could inadvertently reduce benefits or even harm microfinance clients; champion ways for investors to promote responsible finance; and promote “light-touch” business conduct policies and regulations that protect low-income consumers without foreclosing innovations that could offer more and better financial services.

CGAP’s Investor Initiative for Client Protection in Microfinance

CGAP is undertaking a new initiative to ensure that investors have the tools and services they need to incorporate client protection and social performance concerns into their screening, due diligence, monitoring, and governance roles.

Key investors sign on to industry-wide Client Protection Principles
CGAP recently unveiled draft Client Protection Principles at a meeting of key investors in Paris. These principles come on the heels of a broader declaration of ethical practices developed at Pocantico in New York in April. The principles aim to ensure fair treatment of poor clients by providers and call for stronger tools for screening and monitoring microfinance investment.

“A broad coalition is forming and investors are signing on to address issues of investor ethics, accountability, and responsibility,” said Elizabeth Littlefield, CGAP CEO. “This industry-wide initiative addresses the fact that, for microfinance to thrive as a business, we need to find a way to measure and hold ourselves accountable to the highest standards of practice for poor clients. Investors play a key role in identifying and rewarding providers that meet and exceed the minimum standards.”

The principles include the following:
• offering products that don’t put clients at significant risk of over-indebtedness
• promoting transparent pricing
• implementing collections practices that are not abusive or coercive
• implementing complaints resolution mechanisms
• complying with high ethical standards in the treatment of clients, with safeguards to detect and correct corruption and mistreatment
• adequately protecting the privacy of client data

In addition, the principles emphasize the importance of financial literacy skills.

On the policy front: Lessons from South Africa

Striking the right balance between expanding poor consumers’ access to finance while protecting their interests is more difficult than it might sound. As part of its work to identify effective but light-touch regulation, CGAP field-tested a new diagnostic tool for analyzing country-level consumer protection and market conduct concerns on a recent mission to South Africa. We found that while South Africa’s microfinance market is not perfect – it is largely driven by consumer loans, more than half of all insurance policies lapse each year, and bank fees are some of the highest in the world – the country’s long-excluded low-income population is benefiting from innovative policies to balance access and protection.

New market conduct legislation
An unusual feature of the South African financial landscape is the National Credit Regulator (NCR), created by a 2005 law and phased in beginning in mid-2006. NCR oversees any lender – bank, nonbank, microlender, car dealer, clothing store chain, and so on – that makes more than 100 loans per year to households and very small businesses. Its goal is to increase the transparency of credit contracts and rein in “reckless lending” by requiring lenders to prove that they took reasonable steps to ensure the borrower’s ability to repay before extending credit. As economic growth slows and inflation rises, creating the potential for widespread “debt stress,” observers from across the finance spectrum credit NCR for protecting consumers and lenders alike.

Unusual financial sector infrastructure
Another feature of this access-protection balancing act is the existence of voluntary and mandatory institutions (financial “ombuds”) that address consumer complaints in banking, insurance, credit information, etc. Using its new powers to regulate private credit bureaus, NCR has forced a large-scale purging of inaccurate and old data, benefiting millions of South Africans. Another dimension of the protection-access balance is a new class of “debt counselors” to help over-indebted consumers work out their obligations.

Culture, history, and deep-seated behaviors and attitudes are likely to affect the functioning of these credit information, complaints resolution, and debt counseling systems. “The idea that you can bring a complaint against a bank, microlender, or credit bureau and get a fair hearing may seem unlikely to those raised under apartheid,” says McKee. “But South Africa is conducting important experiments that have a lot of potential. It will be important to see how our kinds of clients actually perceive and use these safeguards.”