6 Ethical Concerns in Microfinance: Not as Simple as it Looks

This post was written by Fehmeen Khan, a guest blogger from Microfinance Hub, a website that aims to educate people about the various nuances of microfinance.

Microfinance is a unique credit model that allows capitalism to work in a social context, by creating an optimal mix of profit motivation and social entrepreneurship. This merging of two traditionally-divergent philosophies makes microfinance a delicate balancing act, which increases its vulnerability to criticism on ethical grounds. Here are six ethical questions in microfinance, along with their censures and relevant explanations, that help clarify the intentions of practitioners.

Credit pollution

This occurs when multiple microloans are advanced to individual clients without much consideration of their credit ratings or repayment capacities, because microfinance institutes (MFIs) simply wish to widen their customer base. This behavior is typically driven by intensifying competition in the sector, since a failure to expand or maintain clients will spell failure for the firm. As a result, clients become over-indebted and many defaulters may simply visit the next MFI for a new loan, carrying their debt with them. In the long run, the market may face a repayment crisis, as in Bolivia.

Profit Motivation

Many critics say it is not ‘fair’ to profit from the poor but they fail to realize that interest rates need to be charged to ensure financial sustainability, on account of the less-than-perfect repayment rate (usually 95-98%), overheads, and the high transaction cost of manually extending a large number of small loans to individuals in remote areas. Nevertheless, it is difficult to know the difference between greed and sustainability, as highlighted below.

High Interest Rates

Many MFIs use the above-mentioned justifications  to charge excessive interest on loans, but proponents of the free market economy believe higher rates will attract competition and improve the flow of funds to the poor. Indeed, in the long run, competition will help lower interest rates. However, interest-based income often leads to fat bonuses and paychecks for managers of microfinance providers, and cases like those of Bank Compartamos highlight the severe danger of mismatched financial and social objectives.

Merging business and charity

At the other end of the spectrum lie MFIs that aim to succeed purely as a social business. They employ poor credit control, and as Professor Yunus puts it, ‘credit without discipline is charity’. These firms may forget that being too compassionate will prevent financial sustainability owing to an increasing number of loan delinquencies. Microfinance providers must partner with their client and ensure mutual success, and when borrowers default, their loans should be rescheduled instead of forgiven, or their credit histories should be reset if new loans are sought.

Transparency in pricing

The lack of transparency in pricing is a direct result of high interest rates on micro loans because microfinance providers wish to target as many borrowers are possible, yet profit maximization remains an objective. Hidden transaction fees and sales taxes, complex interest rate representations, and compulsory deposits mean the rate paid by the client is a lot higher than the rate advertised.

Group Lending

In an effort to lower the risk associated with collateral-free microlending, many MFIs practice group lending, which acts as a form of social collateral. This delivers immense advantages in terms of lower costs and cooperation, as a result of which microfinance providers boast high repayment rates, especially among women. This became a moral issue when it was revealed that group borrowing leads to immense peer-pressures that women cannot bear. In other words, the high repayment rates may be a result of the inability of women to bear opposition and disapproval of their group members, and not because they are inherently good entrepreneurs.

Microfinance, like any other social enterprise, has to tackle many gray areas. This context helps us understand the dilemma faced by MFIs on a regular basis, and appreciate the effort put into managing the delicate balance between social good and financial independence.

Gates Foundation Releases 2010 Letter

Bill Gates, perhaps one of the best known names in modern philanthropy has released a statement regarding the goals and ambitions of the Gates Foundation going into 2010.  A must read for anyone curious about some of the major philanthropic projects as we move into an uncertain future.  The statement also highlights Gate’s conviction that the way forward will require innovations – in science as well as the private industrial sector.

Social Media: A New Form of Aid?

There has been a lot of excitement in the business sector regarding innovation in social media outlets.  Regardless if you are talking about social entrepreneurship, or plain business-as-usual, there is no denying that established tools like Facebook and Twitter have already changed the face of business promotion.  Furthermore, it is likely that the impact of these tools and other emerging platforms will continue to expand.  Among the new social business start-ups poised to catch fire is one promoting the fairly novel idea of microvolunteerism: charitable volunteer activities that can be performed in tiny increments of time (1-5 minutes each).  Even better, these mission can be conducted from the comfort of a computer chair, or on the go with a smart phone.

Enter The Extraordinaries, a team based out of San Francisco that collects a number of volunteer activities related to dozens of organizations into one space, offering subscribers the chance to take a crack at any of hundreds of projects – one tiny bite at a time.  Typically, many of the projects offered have been archival or anecdotal.  For example, one can take 30 seconds to tag objects in a photograph for a museum, or send words of encouragement to a struggling student halfway around the world.  Other projects seem somewhat more ambitious, such as searching through legislation for pork, or facilitating the documentation of cases of pollution, water waste, or abuse.  While the vision of co-founder Jacob Colker is admirable, the technology is still very new, and there has been some ambivalence regarding the efficacy and reach of such a ‘crowdsourced’ volunteer approach (see also: NPR’s take).

The winds may be changing however, as earlier last week The Extraordinaries launched a new mission related to the disaster unfolding in Haiti.  By pairing the flood of images pouring out from Port-au-Prince with eager volunteers, the mission aims to facilitate recovery of lost persons by creating a database of tagged images.  Families missing a loved one can go to this database to search, or to post a picture so that others can help them look.  It is a monumentally ambitious project that deserves some attention for its’ novelty alone.  While the effectiveness of The Extraordinaries in this mission is fully dependent on the size and activity of its members, I will surely be watching closely as this project unfolds.  Even a minor victory in this endeavor could have large repercussions for the future of volunteerism, as well as implications for what we can collectively do with our downtime.