investing in the poor the ethics of microfinance

Running Head: INVESTING IN THE POOR: THE ETHICS OF MICROFINANCE

Investing in the Poor: The Ethics of Microfinance

Luke Rzepiennik

Azusa Pacific University

November 11, 2014

INVESTING IN THE POOR: THE ETHICS OF MICROFINANCE 2

Abstract

Microfinance has been hailed as the twenty-first century cure to poverty. The idea of empowering people to lift themselves out of poverty rather than simply being the recipient of charity is attractive to all those fighting the war on poverty. The idea is that it will create sustainability and long lasting economic and social growth. This paper will seek to bring to light the ethical issues that the microfinance industry faces today. These issues include the effectiveness of microfinance, the neglect of the poorest clients, and drift of the central mission of microfinance; highlighting results of research in many different areas. It will answer the question, “is microfinance really as ethically-forward a form of investment as it has been advertised?” It is concluded that it is possible for microfinance be done in a way that is both effective and ethical. Recommendations for reaching these goals are given. They include increased transparency, greater cooperation with other organizations, knowing clients better, and working to drive interest rates down. Through these courses of action it is possible for microfinance to play an effective role in ending poverty.


Section 1: Introduction

In 2005 the United Nations declared it the “Year of Microcredit.” The next year, the

Nobel Peace Prize was awarded to Muhammad Yunus and the Grameen Bank, a leading

microfinance institution (MFI), for their work in microloans. In the last decade microfinance has

been hailed as the cure for poverty; it has been claimed that by providing small loans to the poor

who would otherwise have no access to such financial services, they will be able to lift

themselves out of poverty. This idea is one that makes sense when presented in this manner.

People love the idea that they can both invest their money and help people at the same time.

With this growing trend, research is now finally being done to ask the question, “does it work?”

In addition, MFIs are now being put under a microscope. Many institutions have been accused

ethical violations such as charging unreasonably high interest rates, using exploitative lending

practices, and using forceful methods to recover funds. These issues become even more

prevalent as many MFIs are choosing to transform from a not-for-profit model to for-profit one.

The drive for profit can cloud what is supposed to be the true mission of MFIs, serving the

poorest of the poor. The Prime Minister of Bangladesh claimed that MFIs “are sucking blood

from the poor in the name of poverty alleviation” (Ahmed, 2010: 1). This paper will seek

investigate the effectiveness of microfinance, define the key ethical issues faced by the industry,

and reach a conclusion on whether or not investing in microfinance is truly as ethically-forward

as it has been made out to be.


Section 2: Does it work?

The first step in deciding what to believe about microfinance is to discuss if it actually

works. MFIs are generally seen as a hybrid organization with dual purposes, to do good and to

do well. This means that they are providing financial services and products to those who would

not normally have access to them, but they must also perform well as financial institutions

(Hudon, 2013). MFIs, whether non-profit or for-profit, have real investors that want to see a

return on their investments, whether social or financial. It must be determined if these goals are

actually being met. To do so, the results of microfinance must be examined. Microfinance is a

relatively new trend and therefore has less conclusive data and research available than other

forms of investment; however, there is enough to begin to make some general conclusions. This

section will lay the groundwork to do just that.

2.1: Economic Impact

The first area to be examined is the economic effects of microfinance. To begin, a

macroeconomic perspective will be introduced. Studies show that the emergence of capital

markets has a direct link to economic growth within a country, as judged by gross domestic

product growth per capita (Banco Interamericano de Desarrollo, 2005). Other studies, however,

show that the impact of capital markets is significantly less in developing nations (Levine &

Zervos, 1998). This is because most developing nations lack a comprehensive banking system;

capital markets rely on a fully developed banking system to function efficiently (Prior, 2009). A

lack of access to loans and savings cripple the public from participating in these markets.

Microfinance gives those that have been excluded by the traditional banking system access to

financial services. By giving a broader portion of the population access to savings, loans and


other products, they gain the capacity to participate in capital markets. This creates opportunity

for growth of the capital markets and, in turn, macroeconomic growth can be observed.

A microeconomic viewpoint will now be taken into account. A measure that is often used

in research of this type is ‘average expenditures per household.’ Researchers can track how much

a household is spending before and after microfinance is implemented. The results of these

studies vary greatly. The first and perhaps most obvious variation was seen in those who were

more highly educated or had previous business experience. These people were able to make

better use of the funds that were borrowed. In addition, women on average showed better

economic growth when compared to men. In a study done by A. Banerjee from MIT, it was

found that the number of small businesses in “treated” areas increased by one-third; however, the

average monthly expenditure of the area did not increase. It has recently been argued that

although microfinance often does not affect the average monthly expenditure it does increase the

community’s economic resilience (Banerjee, 2010). An extra source of income makes a

community less vulnerable if there is a fallout in another area of their economy (i.e. there is a bad

fishing season).

2.2: Empowerment Impact

Another measure of success for microfinance is how well MFIs are empowering the

people beyond an economic standpoint. Tavanti argues that for microfinance to work a broader

approach must be taken. MFIs need to invest in the human capacity and the social capital of a

community if it is to thrive and provide a return (Tavanti, 2013). A major issue with many

poverty relief efforts is that although they are attempting to do good and perhaps help in the short

term, they create a dependence on aid. When the effort ends or loses funding, the community it


was serving is left in a far worse spot than they were before the ‘help’ came. Therefore, it should

be the goal of all poverty relief efforts to create sustainability within a community. Rather than

carrying people out of poverty, people should be given a hand up so that they can continue to

grow on their own. This should be a central goal for all MFIs.

Many MFIs have the goal of helping to foster economic equality within communities. By

lending to the poor and the oppressed of the society, like women, it can help lift the entire

community up. However, Mayoux found that lenders became a target for manipulation by the

more influential members of the community. In many cases, the funds borrowed fell under

control of these powerful individuals or groups. Instead of helping to alleviate the income

inequality, the microcredit makes it worse (Mayoux, 2001).

An interesting trend in microfinance is the bias toward lending to women. Over seventy-

five percent of all microborrowers worldwide are women. It is thought that by empowering

women, who are at the bottom of society in many areas, it will help to foster economic equality.

In addition, it is thought that in poor households, men are generally the main source of income.

By giving women the opportunity to also generate income it could increase the overall income

for households. While these are all great ideas, research has shown some flaws in this plan. It

was found that although women are provided with the capital to start bringing in income,

because of their status as women, they are still held to lower income jobs with little room for

growth. It was also found that the funds that women received from microloans often times turned

into household assets which were in turn controlled by men. Discrimination was also found

within the MFIs regarding giving women loans. It was found that the women who wanted to take

on bigger projects were almost always downsized or rejected all together (Hudon, 2013). It

seems that although most of the microloans being issued are going to women, little progress is


actually being made in the area of empowering women. One suggestion for a solution is for

MFIs to offer more accessible savings products. Ashraf is one of the few who have conducted a

study on the effects of microsavings. The study found that women who were given access to

private savings accounts gained decision-making power within their households (Ashraf, 2010).

It seems to come back to Tavaniti’s argument that more is required for success in microfinance

than just providing the funds.

2.3 Livelihood Endowment Status

As previously stated, the problem with many poverty relief efforts around the world is a

lack of self-sustainability within the community that is receiving aid. As soon as the funding

dries up and the volunteers leave, the community falls back into disarray. A main reason for

these types of failures is a lack of understanding of what the community actually needs.

Governments and organizations too often throw money at the problem, not actually doing any

good. In a similar way, if MFIs are not careful, particularly the for-profit institutions, they will

fall into the same trap. What is required is a fundamental shift in how the poor are perceived. The

basis of microfinance as a form of poverty relief is that the poor are actually functioning people

with the ability to, with a hand up, pull themselves out of poverty. This is a brilliant first step to

changing how the poor are seen. The issue that many organizations today are running into is that

they still see poverty as a one dimensional, economic problem. This is not the case. Francis

Njoroge teaches his students of Community Development that poverty is a mindset. People may

be lifted out of economic poverty but unless they are poured into as people, they will never stay

that way; let alone help their community rise above it. Poverty must be seen for what it is,

complex and multidimensional. The solution, therefore, must be equally so.


de Haan developed a model for determining the overall impact that the introduction of

microfinance has had, not just on the economic growth experienced by individuals, but also on

how the beneficiaries have used their assets, focusing on what each culture and community

deems to be required for a “good life.” This model is called the Livelihood Endowment Status

(LES). Rather than beginning with a wealth assessment, as most measures of livelihood do, it

starts with the assets that people value most within the community. Through community

meetings and observations these assets are determined. This creates a base from which to start

measuring as the community strives for not only economic success, but also social, political and

physical advancements. Using this model, a study was conducted that compared the well-being

of microfinance clients to that of non-clients over three years in Uganda. The study found that

although there were gains in the financial asset portfolios of the clients, they saw a loss in social

and physical assets. de Haan concludes that based on these findings clients were no better off

than non-clients after the three years of study (de Haan, 2010).

At the same time another study was done within the same communities but focusing on

the empowerment and social emancipation experienced by women. This study had quite different

findings. It was found that through microfinance, women became more independent, with a sense

of pride in the contribution they were now making to the income of their families. In some cases,

women were even creating jobs that were filled by their husbands. It was seen that women were

beginning to push the boundaries of what in meant to be a women in these rural societies. Some

women even now have their own bank accounts. Women also began to trade in core market

areas, an area previously reserved for men. Perhaps the best indicator of social emancipation in

these areas was the observed increase in property ownership rights. In many areas, particularly in

African communities like those in Uganda, women traditionally have not been? allowed to have


ownership of property. The study saw an increase in women having ownership of land, money

and animals (de Haan, 2010). This diversification of activities and an increase in pride shows

that microfinance indeed can have a great hand in the social emancipation of the oppressed.

Section 3: Responsibilities and Ethical Issues

The senior manager of the microfinance department at Triodos Bank, one of the only

European banks to allow individuals to invest in microfinance, tells us regarding whether or not

to trust a particular MFI, “It all comes back to values. You have to ask what is their main motive

for getting into this business (Dossa, 2014)?” Since 2006 was declared the “year of Microcredit”

more and more MFI have been popping up all over the world. Many see the good that can come

from microfinance work and are striving for an end to poverty; however, there are also those in

the business for reasons centered on exploiting the poor to make money. These institutions may

even see themselves as righteous, making money while helping some people out in less fortunate

situations. As demonstrated in the previous section, however, this is an industry that cannot be

participated in effectively and ethically if the goal of the institution does not remain focused on

helping the poorest of the poor. This section will seek to determine the ethical responsibilities of

an MFI and the current ethical issues that are faced by the industry.

3.1 How Should MFIs View Ethics?

Business ethics is a topic that is constantly being debated because of the many ways a

given situation can be viewed. While some situations may be a clear violation of ethical

behavior, many decisions contain much grey area. Looking at a given situation through various

ethical lenses can be useful in gaining perspective on these matters. A business has the obligation

of having a code of ethics and following it. It can be argued that because of the direct impact the


MFIs have on people, particularly the poor who have no real way to battle unethical practices,

MFIs have an even greater obligation to hold to this code. A code of ethics will help to eliminate

a deviation from the firm’s original mission; in the case of an MFI, to alleviate poverty. The

decision must, then, be made as to which code of ethics an MFI will follow as it makes policy

decisions. This section will discuss how the work of MFIs can be viewed from a virtue,

utilitarian and deontological viewpoint. In addition, it will argue that virtue-based ethics is the

best from of ethics for an MFI to follow.

A utilitarian view of ethics judges the ethicality of an action based upon what will

produce the best result for the greatest number of people. In other words, it is outcome based and

things like reflecting good moral character and high standards become less important

(Chakrabarty, 2013). An MFI that adopted this form of ethics would likely be focused on the

overall impact and financial success of the MFI. While this is an important aspect of an MFI’s

work, this way of thinking can also be dangerous. An MFI that is focused primarily on tangible

results will likely begin to take on more clients that have higher chances of substantial success

and those who really need the help, those at the bottom of the pyramid, will be forgotten. This

form of ethics could also lead to an over-emphasis of the end result of a project; a train of

thought that leads to ‘the end justifying the means’ can also be dangerous. Compromises of

personal or company ethics for the sake of a project are not acceptable. Once corruption begins,

it spreads to infect the entire institution.

A deontological-based code of ethics for an MFI also has its strengths and weaknesses.

Deontological ethics judges the ethics of policies based on rules, laws and regulations. For an

MFI, this would invoke policies directed towards the responsibilities that the institution has to its

stakeholders: employees, donors, investors, and clients (Chakrabarty, 2013). This is an important


viewpoint because without a broad view of the institution an MFI can fail all together and thus

cease to accomplish its mission of alleviating poverty. The issue with a deontological view is

similar to that of the utilitarian view; it is too detached from the core mission of an MFI. As

financial conditions become tighter and more pressure comes from donors and investors, the

well-being of clients can easily be pushed to the way-side.

A virtue-based ethics for an organization focuses on reflecting the moral character of the

institution. The core mission of an MFI is to reach the poorest of the poor and give them a hand

up out of poverty. It is far too easy for an institution to see a drift in its mission as time goes on.

If its code of ethics, however, reflects that core mission of the MFI and the code is not deviated

from, it will help to keep the organization on track. If an MFI is able to keep its main focus on

the client, it can do the most good. The purpose of most businesses is to make a profit; however,

the goal of MFIs is to create change. If it is making money but not truly helping the poorest of

the poor, it is not fulfilling its mission. By creating a code of ethics that is based on the moral

character of an MFI, it can better serve its clients.

3.2 Mission Drift

Another facet of the microfinance industry that needs to be addressed is the growing

number of for-profit MFIs and how they are looking increasingly different from the not-for-

profit (NFP) microfinance institutions. Each type of organization has its own strategic orientation

as well as its own strengths and weaknesses. Supporters of for-profit MFIs note that NFP

institutions face restrictions from donor organizations like project approval, evaluation and

reporting. In addition, NFP institutions are more likely to run into ideological, social or political

issues that work at odds to the institution’s goals. Critics claim that these restrictions reduce the


efficiency of the institutions and therefore limit its ability to successfully manage their loan

portfolios. Other issues such as donor fatigue and lack of diligent management are also potential

hindrances. All these factors make it more difficult for MFIs to become self-sustaining and

ultimately be less effective at alleviating poverty. It is argued that for-profit institutions are in a

better position to create economic gains, being that they are profit oriented. The main issue with

for-profit MFIs, however, is that although they are creating economic gain, the social,

educational and environmental issues that are often the root cause of poverty are more likely to

be ignored (Casselman, 2013).

The neglect of the poor by for-profit MFIs is the phenomenon known as mission drift.

The early pioneers of microfinance set out with the central goal of serving the poorest of the poor

and this remains the mission of many MFIs today. When organizations switch over to a for-profit

model, the focus of the firm also changes. Commercial success becomes the main goal and

serving the poor often falls to the wayside, becoming simply the means for financial gain (Cull,

2007). An example of proof that mission drift is occurring is the reduced lending to women. A

study done by Women’s World Banking that examined MFIs in 29 countries as they shifted from

NFP institutions to for-profit institutions showed that over 5 years the average number of women

lenders went from 88 percent down to 60 percent (Frank, 2008). There is less focus on those who

really need the financial support and more focus on who is going to have the best return rate:

men who have had business experience or higher education. These, of course, are the groups that

need less help.

Considering these things, the question of whether or not NFP institutions are financially

strong enough to make a lasting impact still remains. Most MFIs have a goal of having

community development programs accompany the loans so that there is greater stabilization in


the area and more than just a financial impact is made. The amount of resources required for this,

however, make it difficult for many NFP institutions to apply this. The financial power of for-

profit MFIs could lead to much greater potential for development in this area (Casselman, 2013).

This is the reason that many NFP MFIs decide to shift to a for-profit model. Managers see all

they could do to help the poor if they had the funding and organization of a for-profit institution.

Their intentions are pure and so then the question of how to avoid mission drift becomes a main

focus.

Frank suggests that an open dialogue with potential investors is essential to finding the

right measurements for mission drift in a transforming company. Microfinance works in a

diverse set of areas and so the process cannot be standardized. It follows that the measurements

of success also cannot be standardized. By individualizing the process and the measurement of

success, MFIs can be much more effective. With this in mind, Frank suggests a number of

questions that need to be asked. First, in must be determined who the target clients of the newly

transformed MFIs are. This should be reflected in the mission statement of the MFIs and provide

for how accommodations will be made to ensure continued support of the poorest of the poor.

Secondly, It must be decided what indicators will be used to measure social progress and how

they will be curtailed to the specific areas of investment. Becoming a for-profit institution will

require a greater amount of organization and transparency and so these indicators will have to be

closely monitored and reported to board members and investors. As the MFIs transforms it will

be even more important to keep track of these indicators as the changes in service may affect the

client. Finally, it must be determined how money will be managed. The main goal of

transforming into a for-profit MFI is to have access to cheaper funds; it must be laid out how

these savings will be passed on to clients. A structure should also be set up of how changes in


profitability will change interest rates (Frank, 2008). As previously discussed, many MFIs are

accused of charging outrageously high interest rates; making a plan beforehand and sticking to it

will help to keep this from happening.

Shifting from a NFP to a for-profit model can be highly beneficial for an MFI. Intentions

are often very good but can be lost in the struggle to make a profit. The issues and questions

above are just a few of the ways that can help to keep MFIs on track as they transform. It is clear

that both types of MFIs have value and can be beneficial to their clients. The key to success may

be the forging of partnerships between these organizations to foster both financial and social

gains. As one grows so too will the other, achieving the ultimate goal of poverty alleviation

(Casselman, 2013).

Section 4: Biblical Perspective

A consistent theme in the bible is the heart that God has for the poor and the care that His

people are commanded to have for them. Deuteronomy 10:18 states that, “He defends the cause

of the fatherless and the widow, and loves the alien, giving him food and clothing.” Psalm 9

declares that the lord is a refuge and the poor will not always be forgotten. Christians, in aligning

their hearts and will with God’s, should have the same passion for defense and liberation of the

poor. This passion calls forth action on behalf of the oppressed. There is no question that

scripture supports the fight against poverty. The proper means of fighting, however, are

somewhat more difficult to discern. This section will use scripture to examine the fundamental

practices of microfinance in comparison to the commands that the bible lays forth.

When addressing the Israelites in Deuteronomy, God makes provision for lending.

Deuteronomy 15:7-8 commands that, “If anyone is poor among your fellow Israelites in any of


the towns of the land the Lord your God is giving you, do not be hardhearted or tightfisted

toward them. Rather, be openhanded and freely lend them whatever they need (NIV).” Although

God’s instructions are specifically directed towards fellow Israelites, we know now that we have

all been made one body in Christ and should follow the same instruction of generosity (1

Corinthians 12:13). This passage suggests that microlending to the poor has been going on for far

longer than MFIs have been around. The concept of microfinance is clearly supported by

scripture as a way to help those in poverty. The question comes when we look at other scriptures.

Exodus 22:25 states that, “If you lend money to one of my people among you who is needy, do

not treat it like a business deal; charge no interest (NIV).” Deuteronomy 23:19 makes a similar

command to gain no interest when dealing with fellow Israelites. If the command of generously

lending is applied to everyone, so too should these scriptures forbidding charging interest be

applied. Deuteronomy does allow for the charging of interest to foreigners, but how should it be

decided who is a foreigner? The whole basis of the microfinance industry, particularly in the for-

profit sector, is based on charging interest rates to their clients. In Luke 14:13-14 Jesus says,

“But when you give a banquet, invite the poor, the crippled, the lame, the blind, and you will be

blessed. Although they cannot repay you, you will be repaid at the resurrection of the righteous

(NIV).” This passage encourages not requiring repayment of good deeds; rather, let the good

deeds be for their own sake and repayment will come at the resurrection. These passages seem to

stand contrary to the basic principles of microfinance. How then can these things be reconciled?

As previously demonstrated the practice of providing loans to the poor in nothing new

and is supported by scripture. While other passages seem to contradict the core practices of

microfinance, an answer does exist. Scripture commands that when a loan is given, it should not

be treated as a business deal. The interest a NFP MFI charges is not for the purpose of making


money but for the purpose of sustaining the institution so more good may be done. IF the core

values of the MFI remain intact, their goal will be to drive interest rates down for the benefit of

the clients. The interest rates will only go down as the MFI is able to run more efficiently and

risk is better dealt with. It is much more difficult to reconcile a for-profit institution with

scripture. A focus on profit rather than on people is in conflict with what is taught. This brings

full circle the previously made points regarding the value of virtue ethics and the dangers of

mission drift that for profit MFIs face. It further calls into question the overall ethicality of for

profit MFI as a whole.

Section 5: Conclusions and Recommendations

This paper has introduced many ideas and identified key issues regarding the ethics of

microfinance. This section will bring together each piece of the argument presented and seek to

answer the initial question, is microfinance truly as ethically-forward a form of investment as it

has been advertised?

5.1 Conclusions

The first question that was asked was, “does microfinance work?” This was a necessary

first step to determine whether or not microfinance was effective at alleviating poverty. In the

areas where microfinance is being applied, the number of small businesses increased an average

of one third; it also created greater resistance for the community to economic fluctuations. The

providing of financial services to broader populations within developing countries allows more

people to access capital markets. The growth of the capital markets within a country will help

foster economic development. It was also asked what kind of social impact was being made by

microfinance. While results of studies vary greatly and are largely inconclusive, many good


results have been found. While many issues exist within the institutions and their policies,

positive social change has been observed, including empowerment of women, increased

entrepreneurship, and greater economic equality. It can be concluded that microfinance can work

when done correctly. If done incorrectly or without the correct intentions, the results can often be

damaging; perpetuating dependence and oppression. The circumstances that allow for

microfinance to work are still a matter of debate.

The ethical code that is followed by an MFI is critically important to its success. The

microfinance industry is currently under a microscope for unethical practices and so an MFI

must be ethically sound if it hopes to continue attracting both clients and investors. It was argued

that a virtue-based ethical approach to policy making for MFIs is the best for avoiding mission

drift. It was suggested that increased transparency of MFIs with investors and the industry could

also help keep an institution accountable. There is hope that the ethical issues within the industry

can be overcome and microfinance can become even more effective at alleviating poverty.

Finally, a biblical perspective was examined. It was found that lending generously to the

poor when they need it was a command given by God long before any formal MFI was created.

It was also discovered that fairness and generosity are required in all of these dealings. The loans

should not be treated as a business deal but as an act of good will. As a result, it can be argued

that for-profit MFI not only run a higher risk of experiencing missions drift, but also clash with

commands given by God regarding loans to the poor.

5.2 Recommendations

In 2008, leaders in the microfinance industry came together to address the ethical issues

within the industry. Although each leader came with their own viewpoints and ways of doing


things, they were able to come together to create and sign an official code of ethics for the

microfinance industry (Papini, 2008). This document, called the Pocantico Declaration urged a

few key points going forward for MFIs: (1) Increased interaction between MFIs and other types

of poverty relief organizations (2) Knowing clients better and as a result offering a greater

variety of financial services (3) Greater transparency with donors and investors (4) Better

monitoring of over indebtedness of clients (5) Higher standards of social change, particularly for

those institutions receiving public funds (6) Working towards greater efficiency to drive interest

rates down.

Based on the findings of this paper and the progress made by the Pocantico Declaration,

in can be concluded that there is hope that the microfinance industry can run both efficiently and

ethically. Each of the points made in the declaration is essential to its success. Although there

have been no studies on the effects of the Pocantico Declaration, the fact that these issues are

being thought about and discussed gives hope that the microfinance industry will continue to

grow and make a greater impact.

So is microfinance truly the ethically-forward form of investment that is has been

advertised as? The answer is both yes and no. Microfinance has many ethical issues to work

through. The corruption and lack of diligence are issues that will likely always be present to

some degree; however, if MFIs can come together as an industry and fight against these issues,

progress can be made. It is also up to donors and investors to demand increased transparency and

do thorough research on an MFI before investing. Microfinance may not be the ultimate cure to

poverty; however, it has been shown to be an effective partner in the war on poverty. The

underlying goals and core principles of microfinance are good and ethical and ultimately, worth

fighting for.


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