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Microfinance

Microfinance and Ethics: Three Pivotal Questions

An exploration of questions central to the microfinance debate.

Allow me to pose a question that Socrates may have asked: "What is ethics, and how is it related to the conscience of our society?" Though philosophers around the world no doubt have erudite answers to this question, people with little, if any, knowledge of philosophy use conscience to define ethical norms. But the key here is that our conscience is evolving. Ethics may seem slow to change at times, but it is an important guidepost for the development of our society and always a precursor to the laws we develop. It is quite possible that we are fully within the domain of our laws and yet unethical.

So what are the important ethical questions around microfinance? There are three that are central to the debate:

  1. Is it ethical to do business with the poor or earn profit from poor people?
  2. Is it ethical to maximize profit when doing business with the poor?
  3. Do we have an ethical responsibility to avoid harming poor people in the process?

In my mind, the answer to the first question is yes, you can do business with the poor while earning a fair profit. The answer to the second question is no, you cannot just focus on maximizing profit when doing business with the poor. The answer to the third question is yes, you do have an obligation to your clients.

Allow me to elaborate. To question one: Human beings are economic beings. Self-employment or business activity is what the majority of people do to feed themselves. For hundreds of years, good work was mostly about charity. Societies saw the poor as worthy of our pity but not as hard-working, intelligent, entrepreneurial people. The new paradigm of socially motivated business is using a combination of business and philanthropic ideas to re-shape our system of thinking. Economic development means stability; it also means that people have more freedom to pursue Maslow's hierarchy of humans needs, and thus build ground for political progress that circles back to more economic development. In this way, we can conclude that doing business with the poor is a good thing.

The second question about maximization of profits is more complex. To some extent, it is also very simple. Every dollar in profit that someone makes from poor people comes from the pocket of the poor people. If our objective is to stabilize the lives of poor people, whose income is volatile, we have to make sure that as much as possible of their hard-earned profit stays with them so that they can build assets and create security. The challenge is finding the balance between attracting investors and maintaining healthy microfinance institutions. Deutsche Bank, where I am a managing director, recognizes that profitability, operating costs, and interest rates can vary greatly depending on the microfinance institution’s location, size, growth potential, asset quality, and target market. While the issues are complex, they are not insurmountable. We can use logic and judgment to define what is acceptable for us as social investors, and we can be transparent about our decisions so that others may benefit. In the process, we will certainly make some wrong decisions, but our example may encourage greater profit accountability in others.

While Deutsche Bank recognizes that robust, profitable, well-capitalized, and customer-centric microfinance institutions are necessary for the continued success of the microfinance sector, it also believes in advocating for an industry-wide reduction in client interest rates, which would allow clients a greater share of profits to help build assets.

The third question—do we have an ethical responsibility to avoid doing harm to customers—is an important one, because it requires close attention to customer service and initially may take away from profits. Customer care and ethics are intertwined and inextricably linked. Customer care is crucial to ethics and vice versa. However, every good business in the world recognizes that to be successful, it has to satisfy the customer. More and more, as social investors become interested in maximizing profit and helping the ultimate customer, customer service continues to gain importance. Genuine customer care limits the unintended harm that may occur as we chart new courses. We will make mistakes, but our ethical responsibility to avoid harm is an important beacon as we increasingly engage in business with the poor, with dignity.

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COMMENTS

  • BY Hugh Sinclair

    ON July 1, 2013 08:03 AM

    I applaud Mr. Mahmood’s comments. He promotes transparency and fair pricing, but I have been unable to find a list of the microfinance investments Deutsche Bank (DB) has made and the interest rates these banks charge the poor. Could he explain how and why DB financed the Nigerian MFI LAPO for some years in full knowledge that the interest rates this MFI was charging were appraoching 100% higher than those originally stated? If this bank was helping the poor nonetheless, why was the client desertion rate so high? Or is this one of the wrong decisions he referred to above? DB also invested (and profited substantially) from an equity investment in SKS, the dis-credited Indian MFI implicated in the Andhra Pradesh suicide scandal - did the SKS investment comply with DB’s ethical standards?

    Mr. Mahmood initiated the Pocacinto Declaration advocating client protection standards, which evolved into the Smart Campaign and is now re-branded as TrueLift thanks to a $150.000 donation from Deutsche. If we have a responsibility to prevent harmful impact on the poor, why do the rights of the children of micro-entrepreneurs not earn a mention in these initiatives? Indeed, these self-regualtory bodies and fair-trade style initiatives do not even require that the final use of funds be legal. The work of Chuck Waterfield to reveal the actual APRs charged by MFIs is pioneering, and yet there is not even a requirement to reveal the actual cost of loans in the so-called self-regulatory bodies. If Mr. Mahmood were serious in his claims to protect the poor, I would suggest he begin by being a little more transparent with Deutsche Bank’s own activities, and use his influence and donations to oblige the sector to actually address the issues at hand rather than brush them under the carpet with elaborate window-dressing excercises which fail in the core objective of client protection. Perhaps he could then comment on what tangible steps DB make to ensure the activities they finance are in fact legal. It’s a very simple question - do DB only finance legal micro-enterprises?

    As a final observation, in the quest to reduce interest rates across the sector, would DB state a level of interest which they consider extortionate? While I understand that this is a complex question, if we have no definition of extortion, how do we know if we are avoiding it? The argument that competition will reduce interest rates has not proved effective in either Mexico or Colombia, to state just two cases. So, at what rate does DB become uncomfortable?

  • BY Prof. John Wood

    ON July 2, 2013 06:37 AM

    It’s great to see a serious ethical approach to these questions. To my mind, our financial discourse is belittled by our received assumptions about money, and what it is. Unfortunately, our current model is an attempt to compensate for entropy (non-renewables logic) with a policy of economic growth. Georg Simmel is a worth re-reading, because he shows up some of the limitations of the rather narrow mindset behind economics. Transaction is never a simple exchange of banknotes/gold/numbers etc. The restricted logic of numbers has the effect of isolating ‘profit’ from shared abundance. Hence we use terms like ‘enterprise’ because we see it as a key to unlock ‘money’ by using greed to catalyse work-flow. In reality, entrepreneurship can never be separated from what I call ‘entredonneurship’ (e.g. social innovation). They co-exist on a continuum. So we need a new language of co-innovation that is based on the ‘law of increasing returns’ (ideas + renewables). Once this is achieved, all creative micro-finance schemes would be expected to deliver multiple abundances to many parts of the (shared) ecosystem. Once this happens, a morality of ‘I ought to’ would not be needed.

  • BY Social Performance Task Force

    ON July 9, 2013 03:11 PM

    Asad,

    Thanks for a thought-provoking article. The recent Social Performance Task Force annual meeting took an in-depth look the price and profit questions — and we thought it useful to share here some of the insights emerging from this. Firstly, to the list of complexities shaping an institution’s decisions on prices and profits, we would add the actual cost of funds, including the inefficiencies and/or profit expectations passed on to financial service providers by investors. Secondly, it’s useful to explore the degree to which financial institutions themselves have the capability to set appropriate prices through an effective analysis of their cost structure. Where these skills are lacking, providers set so-called “market rates,” which may be neither fair nor appropriate.

    Beyond this, a key point emerging from the discussion was around the need to keep the client voice at the centre of our decisions around pricing and profits. Do we really understand what clients value, what they would choose to pay for? In the case of a financial institution deciding to allocate a portion of profits to additional client services, how do we know whether clients would opt for such additional services (at the current price) or for lower overall prices? Always asking clients what they value, and then seeking to provide it as efficiently and effectively as possible, will allow financial service providers to be in a much stronger position to set prices and profit targets which balance the needs and priorities of all stakeholders.

    -The Social Performance Task Force

    More on the recent meeting, including the notes on the discussion around prices/profits, can be found here (http://www.sptf.info/sp-task-force/annual-meetings)

  • Dr.Shahzada Irshad Mohammed's avatar

    BY Dr.Shahzada Irshad Mohammed

    ON February 26, 2014 02:19 AM

    Asking for a nominal profit or cost of finance may play a great instrumental role in fueling the self-prestige of a poor borrower. This will draw the line between charity and support to stand up on one’s own feet. I agree on one point that the rate of return should not be fixed on the basis of shear greed

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