Guest Post by: Cécile Koller
Head of Research, responsAbility Social Investments AG
The 2009 Microfinance Banana Skins Report identified credit risk as the number one threat to the microfinance market, while only one year earlier credit risk ranked tenth on the list. What does this change in perceived risk have to do with social performance? The seemingly purely financial risk is putting microfinance’s core mission at stake, which is to lift people out of poverty by providing access to financial services. Credit risk thus is of equal importance for an MFI’s financial as well as social performance.
The sharply increased awareness for credit risk is due to real effects of the economic crisis on MFIs. However, the crisis only uncovered what has already been inherent in the market: a growing risk of over-indebtedness. Thus implicitly, the results of the report call upon the social responsibility of both funders and MFIs by stating that the increase in credit risk is a “self-inflicted risk, caused both by the sharp growth in microfinance lending in recent years due to rising competition, and poor management of credit risk such as inadequate credit assessment (and) multiple borrowing.”
Social performance reporting with a broader scope via the social performance indicators
MFIs report on their social performance activities to the MIX. The reports capture an MFI’s commitment to responsible lending practices and prevention of client over-indebtedness. These indicators measure social performance at the level of a single institution.
To capture social performance, responsAbility is working with the social performance indicators reported on the MIX website. Yet as a manager of microfinance investment vehicles (MIVs), responsAbility considers that strategic allocation of funds has the strongest influence to leverage social performance. MIVs have the capacity to influence markets and the level of over-indebtedness not just by selecting the institutions they work with, but more so by specifically defining target markets. So while the MIX social performance indicators are important, they are not sufficient to provide a meaningful statement on the level of over-indebtedness within the microfinance market.
The reason is that even if an MFI identifies specific measures by which they address avoidance of client over-indebtedness, these measures may have only limited control. In a competitive environment that lacks an adequate regulatory framework with a functioning credit bureau, the irresponsible behavior of other players in the microfinance market will still negatively affect the MFI’s client base, despite the best intentions of the respective institution. Clients can easily become over-indebted through the accessibility of a wide range of microfinance institutions and money lenders. Thus, taking the market environment into consideration for responsible allocation of funds is a key component of an MIV’s investment activities.
The way responsAbility is taking this fact into consideration in its allocation process is two-fold: in terms of market soundness, we carefully assess the market environment, including the dimension of over indebtedness. This is a fundamental factor in our allocation decision. In terms of institutional performance, we analyze each MFI along a development effectiveness rating, measuring the commitment and contribution of each institution to economic development and financial inclusion in addition to analyzing the social quality of an MFI's operations.
It’s about sustainability
By measuring social performance indicators both at the market and institutional level, key factors like regulation and the existence (and use of) a credit bureaus can be taken into account. It allows a lender to avoid contributing to an increase in client over-indebtedness and overheating of a market. Such an analysis turns out to be a sound investment policy for the investor as well. The issue of over-indebtedness shows once again that financial and social performance go hand in hand.
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responsAbility Social Investment AG is a leading player in the discussion on social performance reporting of MIVs. The Swiss-based company currently manages $900 million USD. Since 2005, responsAbility has published an annual Social Performance Report. Its fund structure, performance, fund instruments, and partnerships are available on MIX Market.
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