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This case discusses the phenomenon of microfinance, whereby small-scale financial services are targeted directly at poor consumers in developing countries that have been excluded from the mainstream banking sector. It explains the different forms and providers of microfinance, the challenges faced in using microfinance as a strategy for addressing poverty, and raises questions over the rates of interest charged to borrowers. The case provides an opportunity to explore questions of consumer exclusion, fair pricing, and ‘bottom of the pyramid’ marketing strategies. Microfinance refers to the range of financial services targeted directly at poor customers who are normally unable to access traditional banking services. The reasons for the exclusion of the poor from mainstream banking are many. They include their lack of formal employment, little access to collateral for loans, a perceived lack of creditworthiness, limited banking infrastructure in poor areas, and the unwillingness of banks to service small-ticket financial services (because of the high cost ratio involved). According to most reliable estimates, somewhere in the region of 2.5 billion people lack access to formal banking services. Microfinance seeks to open the doors to poor consumers by developing financial services specially suited to their circumstances. The types of services offered range from small-scale loans (often referred to as ‘microcredit’), to savings vehicles, insurance services, and money transfer services. It is microcredit, though, that has garnered the most attention to date, not least because lending services have been the longest and most welldeveloped form of microfinance. Pioneered in Bangladesh in the 1970s by the Grameen Bank and its founder, Muhammad Yunus (who together won the 2006 Nobel Peace Prize), microcredit can work in a number of ways. The main characteristic, however, is that it is not based on collateral, or even necessarily on any legally enforceable contracts, but rather on a system of ‘group lending’. That is, rather than covering the lender’s risk with assets of the borrower and/ or the threat of legal proceedings, borrowers are formed into small groups where they either monitor one another through mutual trust or are required to guarantee each other’s loans. Repayment is typically organized into instalments with relatively short spacing (often weekly or semi-weekly), the amounts lent are relatively modest (averaging around €100, hence the ‘micro’ label), and services are often targeted predominantly at women in order to address gender inequality issues. Despite the scepticism of traditional lenders, microcredit has proved to be an extremely successful lending model. By 2009, there were estimated to be some 3,500 microcredit institutions, lending to over 150 million customers who otherwise would have been unable to access financial services—or forced to rely on unscrupulous moneylenders in the informal economy. This number has rocketed in recent years, with China alone now accounting for more than 7,000 microcredit companies, having tripled in number from 2010 to 2013. The default rates for microcredit loans, on average, have been considerably lower than for conventional loans. Globally, microcredit repayment rates average around 97%, according to the Microfinance Information Exchange which records data on more than 2,000 microfinance institutions, serving some 94 million borrowers across the developing Case 8 VISIT THE ONLINE RESOURCE CENTRE for links to useful sources of further information on this case Consumers and Business Ethics 381 world. Grameen Bank, for example, boasts a loan recovery rate of 96.7% across more than 8 million borrowers—96% of whom are women. Microcredit institutions have also managed to generate good returns from lending to the poor, with an average rate of return of around 6% per year. The best performers can generate two or three times that amount. For instance, the Mexican microfinance institution, Compartamos, reported a return on assets of 13–18% for the five-year period 2008–12, and profit margins of 30–42%. Beyond microcredit, microfinance providers have increasingly offered a wide array of other services. As well as savings and loans, some microfinance institutions also offer education on financial issues and even social services. In recent years, attention has focused particularly on the introduction of innovative services provided through new information and communication technologies. In 2007, for instance, Vodafone’s Kenyan subsidiary Safaricom Kenya launched a mobile banking service, M-Pesa, enabling money transfers based on text messaging. In a country where only 40% of the 44 million residents have a bank account (around 8–10 million people), M-Pesa has far outstripped this number, with some 18 million users in 2014. The system allows customers to use mobile phones like debit cards, so that they can transfer money between virtual accounts. This enables users to make a range of financial transactions, including the withdrawal and deposit of cash with registered outlets, paying for goods, and even repaying microcredit loans—all simply by sending a text message. Building a path to poverty reduction? In many respects the development of microfinance is clearly a success story. Microfinance has been particularly successful in Asia (which accounts for more than 50% of all borrowers), with countries such as India, Bangladesh, and Indonesia among the largest national markets. Latin America and Africa have also increasingly embraced microfinance practices, and even developed countries such as the US have a small number of providers. Such financial inclusion has enabled those towards the bottom of the economic pyramid to participate more fully in the formal economy, to develop financial literacy and independence, evade the risks and uncertainty of informal saving and lending, and build credit histories that can in turn lead to further accumulation of assets. Some evidence also suggests that microfinance has led to greater consumption (which in turn drives local economic growth), and by extension, can provide greater opportunities for education of borrowers and their families. Although the evidence supporting such claims remains somewhat inconclusive, it does appear fairly certain that if nothing else, microfinance has helped borrowers to smooth their consumption levels so that they are less vulnerable to seasonal variations, such as the vagaries of crop success or failure, or to personal emergencies and natural disasters. Another impact frequently claimed for microfinance is that it has a positive effect on alleviating poverty. Indeed, for many of its advocates, poverty reduction is essentially the raison d’être of microfinance. This is because many microfinance institutions specifically target small-scale microbusinesses, offering financial and other support to create selfemployment opportunities for the poor. That is, rather than providing funds for consumption, microfinance is often directed towards small business start-ups to fuel income generation. These businesses include: cottage industries such as weaving, crafts, embroidery, and jewellery making; microretail businesses such as street stalls, kiosks, and small 382 CONTEXTUALIZING BUSINESS ETHICS shops; agricultural and farming businesses; and a range of small-scale trading operations. By supporting the establishment of these businesses, microfinance providers offer their clients the opportunity to help themselves rather than rely on charity or government handouts. It views the poor as empowered producers rather than exploited workers or passive consumers. To date, though, despite the claims of its many enthusiastic supporters, the evidence on the impact of microfinance on poverty alleviation is limited. In part this is simply due to the relative youth of the industry, as well as the very real problem of providing any definitive correlations given the range of variables involved in determining poverty levels. Despite numerous case studies of successful initiatives, hard empirical evidence is lacking, and where researchers have managed to conduct appropriate studies, the results have often been contradictory. However, one of the most extensive reviews by David Roodman who gathered data over three years from hundreds of lenders and borrowers in microfinance institutions to research his 2012 book Due Diligence: An Impertinent Inquiry Into Microfinance, concluded that ‘on current evidence, the best estimate of the average impact of microcredit on the poverty of clients is zero.’ At best, the existing evidence seems to suggest that, on average, microfinance reduces vulnerability and dependence among client groups, even if it does not necessarily make them richer. And certainly many small businesses supported by microcredit have thrived, even at times bringing new and much-needed new goods and services to poor areas. A good example is provided by the Grameen ‘telephone-ladies’ who use Grameen Bank loans to buy mobile phones and offer phone services in Bangladeshi villages previously without accessible telecommunications. The project has enabled hundreds of thousands of telephone-ladies to start businesses, many of which have proved to be profitable. Some critics though, such as Aneel Karnani, a professor at the University of Michigan, have raised a more fundamental criticism of microfinance and its impacts on poverty reduction. According to Karnani and other critics, microfinance can actually hinder efforts to reduce poverty because it diverts attention and resources away from other more proven ways of promoting economic development such as the creation of employment through small and medium-sized enterprises (as opposed to microbusinesses and selfemployment). As he argues: rather than giving microloans of $200 each to 500 women so that each can buy a sewing machine and set up a microenterprise manufacturing garments, it is much better to lend $100,000 to an entrepreneur with managerial capabilities and business acumen and help her to set up a garment manufacturing business employing 500 people … Microcredit, at best, does not help to reduce poverty, and probably makes the situation worse by hindering more effective approaches to poverty reduction. One need only look to China to see how poverty reduction can also be achieved through supporting the introduction of larger-scale industry. Amongst the supporters of microfinance, such views are contested, not least because the innovativeness of the model means it has the potential to offer a more organic, inclusive, bottom-up approach to poverty alleviation than traditional models. That said, even the most ardent supporters recognize that more work needs to be done to refine the model, and to evaluate where it can and cannot have a material effect on poverty. Consumers and Business Ethics 383 Balancing the books Another challenge facing microfinance is its underlying business model, and the degree to which microfinance institutions can (or should) balance business success with explicit social goals. At one end are microfinance organizations operated by civil society organizations, or those directly funded by government or charities, which put a premium on poverty reduction and other social goals. At the other extreme are commercial banks, which have increasingly entered the microfinance market as a result of the model’s proven results in generating returns and keeping default rates down—as well as its relative immunity to the recent global financial turmoil. Approximately one-third of all microcredit borrowers are now served by non-profit institutions whereas up to two-thirds are actually served by commercial financial institutions. Commercial microfinance institutions are more likely to involve larger loans, fewer women customers, lower costs per dollar lent, higher costs per borrower, and greater profitability. Among the banks involved in microfinance major multinationals such as Standard Chartered, HSBC, and Deutsche Bank have rubbed shoulders with numerous smaller, local players. The big banks typically operate microfinance as a niche offering among their broader portfolio of products and services, and emphasize the need for it to demonstrate its commercial viability. To date, commercial banks have tended to fluctuate in their interest in microfinance, depending on the financial results they have generated. However, in India domestic banks are required by law to set aside 40% of their reservable funds for the ‘priority sector’, which includes microfinance and financing of ‘small-scale industries’. In between the two extremes of non-profits and big banks is a large swathe of dedicated microfinance institutions, ranging from those, like Grameen, that are set up with a distinct social mission, to those, like Compartamos in Mexico, that have a more explicit commercial orientation—but all seek to operate on a secure financial footing. Wherever they might fall on this continuum, the aim of almost all microfinance institutions is to marry pro-poor business models with some degree of economic viability. The problem comes with determining how the right balance should be reached. Providing financial services to the poor may not be as risky as once thought, but it remains expensive because of the large numbers of small transactions that need to be processed and the considerable resources that need to go into developing education and outreach services. For this reason, a number of microfinance organizations continue to rely on donors. However, among those like Grameen and Compartamos that have proved they can become sustainable without additional funding, there remain unresolved questions about what kind of pricing model they should adopt. When Compartamos, one of the largest microfinance institutions in Latin America, held an initial public offering (IPO) of its stock in 2007, the sale was oversubscribed by 13 times, and the bank’s valuation shot to $1.6 billion, making millions for its owners. The bank’s financial success, however, rested on an aggressive business development strategy that had seen the company reap high profits from its microcredit business. At the time of the stock offering, Compartamos’ borrowers were paying interest rates of more than 90%, a quarter of which went straight into profit. Whilst this certainly demonstrated once and for all that microfinance had the clear potential to attract the private investment necessary to expand rapidly and service more clients, critics suggested that the bank’s practices were tantamount to ‘microloansharking’. The levying of high interest rates on the poor, the argument went, was against 384 CONTEXTUALIZING BUSINESS ETHICS the very purpose of the movement: microfinance companies were supposed to be social businesses, not cynical moneylenders. ‘Microfinance’, one commentator noted at the time, ‘has lost its innocence’. The tensions in commercial microfinance have if anything intensified since that time. SKS, the largest microfinance company in India, became the country’s first microfinance IPO in 2010. The offering attracted leading investment groups, such as Morgan Stanley and JP Morgan, and like Compartamos was substantially oversubscribed. The company valuation reached $1.5 billion, and five weeks after trading began the share price had risen by 42%. However, the company, and commercial microfinance companies in general, were soon mired in controversy regarding their role in a spate of 200 suicides in rural Andhra Pradesh, the country’s microlending hub. Evidence emerged that many of the suicides were by defaulting borrowers who had experienced forceful collection of loans, public shaming, and communal harassment from other borrowers, including orchestrated sit-ins outside their homes. Police jailed microfinance employees, including dozens from SKS. Among the charges was abetment to suicide, essentially driving people to kill themselves, a crime under Indian law. According to a Wall Street Journal report, one woman drank pesticide and died a day after an SKS loan agent told her to prostitute her daughters to pay off her debt, while another SKS debt collector told a delinquent borrower to drown herself in a pond if she wanted her loan waived. The next day, she did. Investigations suggested that SKS employees had overlooked its basic lending principles in a quest to diversify their client base and thereby appeal more to investors. The Indian authorities quickly clamped down on the lending practices of microfinance companies. Other suggestions to prevent exploitation by microlenders have included Muhammad Yunus’ advocacy of a legal cap on interest rates. To date, though, the legal route has not been widely followed, although government pressure, market dynamics, and company priorities have led to a substantial variation in interest rates across countries and companies. The global average is currently around 30%, which is considerably higher than for conventional lending. This, most commentators agree, can be justified to some extent by the higher costs involved in servicing small loans. Nonetheless, many lenders charge considerably more than this, with some lenders in Africa, Latin America, and the Caribbean imposing rates of up to 80–90%. Perhaps, though, given the aim of many in the microfinance community to prove its commercial credentials, the high interest rates should not come as too much of a surprise. As one leading figure in the industry remarked, ‘To attract the money they need, microfinance institutions have to play by the rules of the market. Those rules often have messy results.’

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