64993 foCuS noTe Responsible Finance: Putting Principles to Work E arly microfinance pioneers created the sector with the aspiration to improve poor people’s lives. There were huge swathes of “white space� proposition and provider risk management. Other mechanisms that could have helped manage the growing risks, such as effective credit information where low-income households had little or no sharing systems, were not in place.1 access to formal finance. This challenge, in turn, demanded sustainable and scalable models for The credit crises brought into focus the short- delivering adequate financial services to poor term trade-offs that may exist among the quantity, people. quality, diversity, and reach of financial services delivery. We need to better manage the trade- This is the essence of the double bottom line in offs to ensure that products and practices are microfinance: a social commitment to benefiting sound and client welfare and institutional viability clients married with a financial commitment to are not put at risk. Scale and sustainability goals operating profitably. In the long run, these two remain legitimate and, indeed, critical goals, objectives do not contradict each other: doing right but they must be supported with the necessary by all stakeholders is the only long-term sustainable infrastructure, such as credit bureaus, and business solution. Over time, the market should public goods, such as transparency regulation. 2 reward retail providers that adequately protect In sum, we need to rebalance the double bottom clients’ interests, affirmatively treat them well, line as our collective goal shifts from simply filling offer a product line responsive to their needs, and in the white space to developing a healthy and deliver good value for money. In the short run, responsible market. however, tensions can arise. Against this backdrop of high aspiration and new Tensions are evident in the microfinance sector— challenges, the microfinance field has embraced in the recent repayment crises, local microcredit the need for a proactive responsible finance agenda markets suffered from overly rapid growth, and accelerated its efforts to implement meaningful resulting in loss of credit discipline, multiple improvements in products and practices. There is lending, and instances of over-indebtedness. a growing consensus that providers of financial There were powerful social and financial reasons services to the poor must adhere to a standard to scale up quickly, and investors were eager to of care that minimizes risks for their customers, back this rapid expansion. In retrospect, however, who typically have low and variable incomes, little we see that lenders in these markets—and indeed margin for error in financial decision making, and in the microfinance field as a whole—may have limited formal education and exposure to formal overestimated the demand for credit. Saturation finance.3 occurred more quickly than expected, particularly since microcredit institutions often competed for In this paper, we define what we mean by No. 73 September 2011 market share in the same client segments and responsible finance, both as an end-state vision and areas rather than reaching out to less served areas. in terms of a pragmatic focus on client protection Katharine McKee, Internal systems, including controls and staff and social performance management to help Estelle Lahaye, and development, failed to keep pace with growth. achieve our goal. This paper explores the state Antonique Koning Regulation did not permit these nonbank providers of responsible finance knowledge and practice, to offer other services, such as deposits, that with a focus on three mutually reinforcing client would have improved both the customer value protection strategies: 1 See Chen, Rasmussen, and Reille (2010) and CGAP (2010). 2 Transparency is a general problem for all financial services, since their features and quality are difficult for consumers to assess fully before purchase. This information asymmetry between providers and consumers is exacerbated when consumers are unfamiliar with formal finance and have little choice among providers and products. Transparency regulations, such as disclosure requirements, seek to address information asymmetries and can also take into account behavioral biases. 3 See, e.g., findings from financial diaries research such as that analyzed in Portfolios of the Poor (Collins, Morduch, Rutherford, and Ruthven 2009). 2 • Industry self-regulation. their mission. Collateral benefits from good social • Government regulation and supervision. performance include a positive corporate culture • Improved consumer capability. and good employee morale. Recent studies have shown encouraging evidence of a “virtuous circle� It also examines emerging practice to support the of positive links between financial performance, basic premise of social performance management— responsible practices, and commitment to that business processes must be aligned with mission social returns in the microfinance sector. 5 and, ultimately, deliver on the promise of client This resonates with a premise gaining ground in benefit. It then describes funder roles in promoting the mainstream corporate world—that the best way responsible finance and closes with observations for corporations to do well is by creating shared about future implementation challenges. value for customers and communities as well as shareholders (Porter and Kramer 2011). What Is Responsible Finance? To bring this about, our practical focus in responsible delivery of financial services to the In a financial world characterized by responsible poor is on client protection and social performance. finance, clients’ benefits would be balanced carefully with providers’ long-term viability, and client From the perspective of client protection, protection is built into the design and business at providers need to have appropriate products, every level. Products are thoughtfully designed, offer policies, and practices, and clients need to have the reasonable value-for-money, and minimize potential basis for making informed choices, understanding harm, such as over-indebtedness. Delivery practices their rights, and meeting their obligations. And are respectful, and do not rely on aggressive sales, effective recourse mechanisms need to be in coercive collections, or other inappropriate behavior. place. These basic conditions need to hold for Clients receive clear, comprehensible information so any provider of financial services to lower income they can make informed and careful choices about and less experienced consumers, regardless of financial products and providers. When problems or the provider’s specific mission, profit goals, or misunderstandings arise, customers have accessible ownership structure. and effective mechanisms for resolving them. Other actors come into play to reinforce responsible Within a few years, this vision of responsible finance retail service delivery. Governments can regulate could bring discernible improvements in the with clear, enforceable, and “access friendly� market appropriateness and quality of services. Responsible conduct rules. They can also help catalyze consumer providers would benefit from enhanced customer awareness and financial capability initiatives. Donors loyalty and trust, opening the door to cross-sale of and investors can create appropriate incentives by additional services, new deposits, increased market supporting standards development and rewarding share, and brand enhancement. Many measures improved products and practices. The media and that protect clients also help providers manage key civil society can help by shining a spotlight on operational risks and reduce the likelihood of heavy- irresponsible practices and supporting consumer handed regulation or political interference. The awareness and rights. institution might attract more and better financing from investors that seek strong social returns. In respect to social performance, many industry players need to go beyond the “do no harm� Those providers with a double bottom line 4 standard of client protection to measure and would also hold themselves accountable for achieving manage progress against a specific social mission, 4 “Double bottom line� refers to socially responsible enterprises and investments that measure their performance in terms of positive social impact, as well as the more traditional financial bottom line of financial profit or loss. “Triple bottom line�—also sometimes referred to as “people, planet, profit�—goes further by adding environmental accountability into business—or investor-level performance metrics. 5 See Gonzalez (2010) and Dewez and neisa (2009). 3 ensuring the mission is translated into client standards development, (ii) consumer protection benefit and appropriate behavior toward staff, the regulation and supervision, and (iii) efforts to improve community, and the environment. Microfinance was consumer awareness and financial capability. 7 created as a client-centric enterprise, and almost These elements of the strategy to promote client all retail providers in the sector commit to specific protection, though articulated in terms of three client benefits and strive for a business culture different actors, are not mutually exclusive and, in that reflects those core values. The most common fact, overlap and reinforce one another. objectives are outreach to the underserved, poverty reduction, and empowerment of women. Two sets Industry self-regulation needs to be at the core. of metrics—one focused on financial performance By definition, microfinance services tend to work and the other on social performance—hold with poor households in the informal economy retail providers accountable at the process and and to happen in countries with limited regulatory outcome levels for their double bottom line. Social and supervisory capacity. The onus on bringing performance metrics assess progress in reaching about responsible finance and protecting clients their intended clients, providing financial (and is first and foremost on providers themselves. sometimes nonfinancial) services that meet clients’ Financial services delivery entails risks, credit life-cycle needs, and bringing about positive markets are prone to boom-and-bust cycles, and change in their lives. They also help hold providers there are inherent imbalances of information and accountable for soft money received in the form of power between providers and their clients. There grants, financing on attractive terms, or subsidized is growing consensus among providers and their technical assistance. supporters, such as social investors, that it is both right and good business to adhere to a standard Over the past decade, leading practitioners of care that provides value and minimizes risk for around the world began exploring responsible clients while at the same time helping the provider finance by developing codes of conduct and tools manage its own risks. to better measure, manage, and improve their social performance. This first-generation work That said, self-regulation may not have sufficient focused on putting client interests and outcomes coverage and enforcement power to ensure (such as improved money management, incomes, adequate client protection. Regulators and policy assets, security, and empowerment) at the center, makers in developing countries are beginning to while improving institutional efficiency, scale, and put in place basic consumer protection rules to profitability. Progress on the social performance complement and reinforce industry initiatives by front was closely followed by a wave of innovation strengthening transparency, fair treatment, and and tools around client protection.6 effective recourse. And there is growing recognition that lower income households at the base of the Three Strategies to Advance pyramid need to do their part for responsible Client Protection finance by developing the skills, knowledge, and attitudes that help them “self-protect“ and better Client protection is at the heart of responsible navigate financial decision making. Governments, finance. The three key ways to promote client consumer organizations, development agencies, protection are (i ) industry-led initiatives, such as and researchers are working together to address client protection-focused codes of conduct and this particular challenge. 6 The pioneering “Beyond Codes� action research project laid the groundwork for industry-wide initiatives by analyzing current practices of diverse microfinance providers against the new client protection principles. It documented specific areas for improvement and helped raised awareness about the need for increased efforts to promote responsible finance. Synthesis report available at www.smartcampaign.org. Recent research directly with low-income consumers in developing countries supports these findings. 7 The term “client protection� refers to the obligation of retail providers to behave appropriately in regard to their own clients. The term “consumer protection� is broader and refers to the responsibility that other stakeholders, such as policy makers and regulators, have to ensure transparency and fair treatment across the entire market. 4 Industry initiatives Box 1. Partner Microcredit Foundation’s Approach to Over-Indebtedness in Over the past decade, many international Bosnia microfinance networks, national associations, The Bosnian microcredit sector has experienced and individual retail providers have committed to high competition and fast growth, which improved transparency, fairness, client protection, contributed to a serious crisis in the sector in 2008– and social performance by putting in place codes 2009. Some providers may not survive. Others are of conduct, financial education for customers, overhauling their credit processes based on analysis of what went wrong. In 2007, Partner Microcredit and other measures. Some of the codes also Foundation began crafting a comprehensive incorporate emerging good practices in customer approach to prevent, detect, and correct client service relationships, business ethics (e.g., not over-indebtedness. Partner recognizes that a risk pursuing unfair practices, such as poaching staff for the client means a risk for the institution. It has integrated this philosophy into its organizational from competitors), and social performance. Overall, culture, and built systems and procedures to however, incentives for code compliance have not support it: always been strong enough to overcome short- • Loan officers conduct thorough borrower run temptations to cut corners, and sanctions for analysis, including field visits, business noncompliance were weak. Recent experience diagnostics, and checks with credit bureaus. has strengthened resolve to improve responsible • Internal auditors detect violations of policy finance practices, with progress evident at the through random spot checks and branch visits. • Both staff and clients receive financial education level of individual microfinance providers, national training and information, to enhance customer networks, and global initiatives. service and clients’ decision making. • Partner conducts regular surveys, focus groups, To some extent, addressing responsible finance client exit monitoring, and mystery shopping to ensure that products are appropriate and challenges at the industry level requires better institutional behavior is client-centric. understanding and overcoming some limitations of the first generation of microfinance products Source: Smart Campaign (2010a). and practices, including limited product flexibility and diversification. This also means ensuring that incentives are well-aligned for all parties in National microfinance associations can reinforce financial transactions, such as adjusting loan officer and complement action by individual providers, compensation arrangements to reward portfolio such as Partner and FinComún, at a sector level, quality and customer service as well as volume. for example, by organizing their members around The recent crises and the growing commitment to improved credit information sharing, coordination responsible finance have accelerated innovation of branching and expansion strategies, and client to lay the base for this next generation of education. microfinance products and practice. There is also greater awareness of trade-offs that might arise in Preventing over-indebtedness and ensuring balancing the double bottom line and how these transparency and fair treatment are receiving trade-offs can be addressed. Boxes 1, 2, and 3 increasing attention in other countries as well. illustrate some of these challenges and solutions. Providers and their associations are taking steps to improve how prices, terms and key conditions, One particular area for improvement identified and risks are disclosed and communicated to by practitioners is working with clients at risk of clients. For example, at a recent retreat on client delinquency and default. Several of the crises protection, leading Indian practitioners, the served to highlight the limitations of the “zero two main microfinance associations, and other tolerance� approach that tended to characterize stakeholders identified the need for specific the first generation of microcredit risk management improvements in product design and pricing, models. Many lenders are now revising their marketing, group formation, disclosure, lending delinquency handling and collections processes. and collections processes, and use of third-party 5 Box 2. Collections with Dignity at Box 3. Pakistan Microfinance Network FinComún, Mexico Consumer Protection Initiative When FinComún faced rising default rates in 2008, Pakistan’s microcredit sector experienced a crisis it revamped its collections process to focus more on in late 2008 and early 2009.a Analysis revealed that client outcomes in loan recovery. The “Collections credit underwriting and client protection practices with Dignity� approach enabled FinComún to had deteriorated as competition increased. In strengthen client relationships while increasing on- response, Pakistan Microfinance Network (PMN) time payments and mitigating some of the effects launched a consumer protection initiative that aims of the global financial crisis on its loan portfolio. to improve practices through a voluntary code of conduct and related measures. The code of conduct The approach is client-centered and promotes offers PMN’s members—which include regulated listening to clients and building relationships so microfinance banks as well as unregulated MFIs—a as to understand each situation, maintain mutual common client protection vision and guidance trust, and lay the basis for exploring repayment to improve practices. Four components support options and agreeing on solutions. Negative labels, implementation: such as “delinquent clients� are avoided. Human resource management is essential to the success 1. Dissemination. PMN trains staff of PMN’s of this new process. FinComún stopped using members, clients, and policy makers on the code. outside collection agents and redesigned its hiring, 2. Standardization of pricing and disclosure training, and performance evaluation to support policies. Using the existing regulation as a the new philosophy. starting point,b PMN is working with members and the central bank to develop a common Source: Smart Campaign (2010b). method for calculating product prices and disclosing prices for both regulated and unregulated providers. PMN also advocates for its members to adopt standardized pricing tools agents. One senior executive reported that his MFI developed by MFT and the SEEP Network. had internalized the code through staff training, 3. Code monitoring and compliance. Members are required to monitor compliance. PMN limits on certain collections practices, targeted developed a tool for internal and external communications to clients orally and with local- auditors to score members’ compliance with language signs in branches, and a toll-free phone the different values in the code. After the pilot, PMN expects all stakeholders (e.g., central number for grievances. Actions are underway bank, rating agencies, funders, local apex) to to reinforce the associations’ codes, including a use the tool to appraise provider practices. new Lenders Forum and independent appraisals 4. Implementation of a client grievance redress commissioned by the State Industrial Development system. PMN is establishing an independent redress platform. When a client registers a Bank of India to assess its investees’ compliance grievance, a trained PMN staff member works with the code (Microfinance India Summit 2011). with the provider to investigate and resolve the issue. PMN will also report recourse data to the Microfinance Transparency (MFT) is a global central bank’s consumer protection department (for regulated MFIs) and the Pakistan Poverty initiative focused specifically on improving credit Alleviation Fund (for unregulated MFIs). price transparency across the industry. It collects Source: Smart Campaign (2010c) and interview with PMN staff. and disseminates national-level price data by type of a See Chen, Rasmussen, and Reille (2010) and Burki (2009). credit product and facilitates in-country discussion b In Pakistan, the central bank regulates the pricing and among providers, policy makers, funders, and disclosure policies of microfinance banks. Unregulated MFIs (nongovernment organizations, cooperatives, etc.) determine others about how to improve price transparency.8 their own policies. It is active in 28 countries and has collected price data for more than 1,000 different loan products sold to over 50 million clients. and responsibilities, ensuring appropriate sales and collections practices, improving complaints Clear progress is also evident in many countries handling, and training and rewarding staff to on informing clients more fully about their rights exhibit the highest level of personal integrity. 8 See, www.mftransparency.org 6 Building off this work by providers and associations, the industry-wide Smart Campaign was launched Box 4. Smart Campaign’s Client Protection Principles late in 2009. Seven core client protection principles (CPPs), developed and recently revised through 1. Appropriate product design and delivery 2. Prevention of over-indebtedness widespread industry consultation, form the 3. Transparency cornerstone of the Campaign (see Box 4), which 4. Responsible pricing provides practical support to turn these principles 5. Fair and respectful treatment of clients into action. By mid-2011, Campaign endorsers 6. Privacy of client data 7. Mechanisms for complaint resolution numbered more than 640 retail providers, from 130 countries (serving an estimated 50 million clients), 225 associations and support organizations, and 125 funders (including most of the largest).9 of the cases and satisfactory performance in only 20 percent of the cases. This is consistent The Campaign’s main focus now is on moving from with the divergence Smart has found between principles to action. It has collected examples MFI perceptions and results for those same MFIs of good practice from diverse providers and has that have gone through its thorough assessment developed training and Web-based tools that offer process.10 detailed guidance (organized by principle and by type of financial service) to help retail institutions Finding credible ways to validate performance is a assess the adequacy of their current product critical part of moving from principles to standards features, processes, and policies. Additional and benchmarks. The Campaign convened tools serve third-party assessors (such as raters), specialized microfinance ratings agencies and social networks, and associations. To date, Smart-certified auditors to share experiences in integrating client consultants have conducted in-depth assessments protection within existing tools and to develop of 23 MFIs. Memoranda of understanding with 30 a single tool for validating MFI compliance with national and regional microfinance associations CPPs. Launch of the certification tool is slated for help organizations, such as PMN, to strengthen early 2012. their member MFIs’ client protection efforts. Consumer protection regulation Client protection practice is evolving rapidly, particularly in the areas of credit policies and In Peru, the lead financial sector regulator (the procedures and transparency. Of the MFIs Superintendent for Banking and Insurance) reporting to MIX on how they are integrating client has pursued a deliberate strategy to improve protection into their operations, roughly two-thirds transparency and fairness in the market. It cited measures in these areas, and just over 40 established a simple disclosure regime for credit percent reported improvements in collections, products and gradually extended its coverage redress of grievances, privacy of client data, and beyond banks to additional lenders. This appears to ethical behavior by staff. Only 15 percent reported have improved comparison shopping by consumers applying all the principles at this point. It is also and price competition among regulated providers, important to note that these data are self-reported, contributing to meaningful drops in prices.11 Now, and the gap between reported and actual practice the Superintendent is turning to deposits and might be large. In fact, Planet Rating found that recently put in place new disclosure requirements 70 percent of the MFIs it rated are in the process for these products (which led some banks to reduce of implementing the principles. However, the fees and commissions in advance of the data rater found room for improvement in 50 percent becoming public). Insurance is the next candidate 9 See www.smartcampaign.org for detailed guidance, tools, and emerging good practices. 10 The Smart Campaign (2011) commissioned a study to evaluate how CPPs are being adopted in the industry. 11 Peru’s Superintendent for Banking and Insurance (www.sbs.gob.pe), MfTdata (http://mftransparency.org/data/countries/) and unpublished CGAP research. 7 for a stronger disclosure regime. The regulator consider the characteristics of lower income and engages very actively with the public through the less experienced consumers, provider compliance media and has taken steps to improve consumers’ costs, and the regulator’s own capacity for market access to dispute resolution mechanisms, promote monitoring and enforcement. Consumer research responsible lending practices, and monitor consumer can be an essential tool in pinpointing priority protection in branchless banking services. problems and how they might be addressed. 12 A proportional approach can leave space for Other countries are moving forward as well. Some innovation, by monitoring the actual risks in the years ago, the National Bank of Cambodia put in market and phasing in new rules to address them place a simple requirement that MFIs state their rather than placing upfront restrictions on new interest on a declining rather than flat rate basis. The approaches and business models. Central Bank of Ghana requires regulated providers to give consumers a “Key Facts� document that This step-by step approach would start with states all key prices, terms, and conditions of transparency problems or practices in the market the product. Regulators in other countries have that affect many consumers. For example, in provided guidance on ensuring that collections some countries, regulators first have required practices are effective but nonabusive. The South that providers use the declining balance method Africa National Credit Act established a flexible, but to state loan interest rates or place the most firm, requirement that all lenders analyze borrower critical product information in a preclosing “Key repayment capacity and determine that their Facts� document. This can create a foundation loans will not over-indebt customers. The Central for improved transparency without imposing Bank of Kenya’s recent banking agent regulations undue costs on providers or overstretching extend certain protections to branchless banking regulatory capacity. Later on, more ambitious and customers. comprehensive approaches, such as standardized price formulas or cooling-off periods, 13 might Consumer protection regulation aims for be justified if there is evidence that the simpler transparency, fair treatment, and effective measures are not achieving the desired results. recourse. The tools to achieve this include rules These safeguards are likely to strike a better that require providers to disclose product prices, balance than more intrusive measures, such as terms, and conditions with reasonable accuracy interest rate caps. To improve recourse, regulators and comprehensibility; have responsible lending can work with financial service providers and their safeguards and checks against aggressive sales or associations to agree on standards for receiving and collections; and offer accessible and even-handed resolving complaints, including measures to make channels for clients to resolve disputes. Regulators sure that recourse options work for consumers with also sometimes work together with industry leaders lower levels of education, income, and financial and associations or funders to build needed market sophistication. This option is feasible for regulators infrastructure, such as more inclusive and accurate whose capacity is too limited to provide recourse credit bureaus. themselves. Once the market is more developed, initiatives to create third-party recourse options for As the only actor with the power to establish consumers may be appropriate, whether through legal standards, governments have considerable financial sector regulators, industry associations, power to improve practices. Consumer protection or specialized ombuds. regulation can advance responsible finance, if it is designed and implemented with sensitivity to Setting basic standards and “rules of the game� financial inclusion goals. Policy needs to carefully protects clients; it can also protect responsible 12 e.g., a comprehensive consumer protection diagnostic process in Kenya benefited from extensive consumer research through focus group discussions and a representative national survey. See fSD Kenya (2011). 13 A cooling-off period permits a consumer to cancel a contract within a specified period of time from the sale. It aims to guard against pressure sales and provide the consumer the chance to review product terms and conditions fully. 8 providers against unfair competition. This could is encouraging evidence that, in markets where become more necessary as purely commercial some providers are covered by transparency rules players—that might be less likely to participate and others are not, unregulated providers tend to in industry standards development and feel adopt the same standards as their regulated peers less pressure to conform to codes—enter these over time (Pistelli, Simanowitz, and Thiel 2011). markets. The credit crises showed that short-term incentives to cut corners can arise as markets Successful self-regulation might have more begin to get saturated and competition heats up. potential for an issue such as complaints handling, Carefully designed regulation could help ensure where compliance costs are lower and short- that increased access is healthy for consumers and run business advantages (customer satisfaction providers alike. and retention, feedback on service quality improvements) are more obvious. Targeted Many governments in emerging and developing consumer awareness efforts could strengthen client countries are putting in place new financial use of new mechanisms, and associations might be consumer protection laws and regulations and the able to monitor and sanction inadequate practices. institutions to implement them (CGAP and World Experience from other sectors also suggests that Bank 2010). The imposition of these “rules of the self-regulation might itself be more effective when game� does not appear to have had a chilling the regulator engages actively in observing it and effect on innovation and expanded access for appears willing to step in should it not succeed. A poorer and underserved consumers. For example, formal role for regulators in overseeing industry MIX data suggest that Peru, Cambodia, and Ghana self-regulation, such as codes of conduct, is have experienced strong gains in the quantity and becoming more common. diversity of financial services on offer. However, consumer protection regulatory experience is Consumer awareness and still quite limited in developing countries, and financial capability much remains to be learned. For example, the challenge of making disclosure and recourse Neither industry initiatives nor regulations are work for consumers with limited literacy, formal likely to succeed fully if consumers are not aware education, or knowledge of formal finance is not of their rights and responsibilities. To benefit trivial. Policy making would benefit from further fully from access to formal financial services, documentation, analysis, and exchange among clients need improved information, skills, and regulators, industry players, researchers, and other attitudes. More “financially capable� consumers important microfinance stakeholders. can select appropriate products, take steps to protect themselves from products and practices Regulation by government versus self-regulation by that are not in their best interest, and comply with industry is not an either/or proposition, of course. the terms of the financial products they use. This Some problems, such as price transparency, may behavior, in turn, rewards responsible providers be too difficult for providers and their associations and products and mobilizes consumers’ “power of to resolve on their own. Individual providers can their feet� to favor those that adhere to acceptable profit from deliberately understating their prices, practices. This also helps to reinforce the business and the ability of industry to self-police may be case for responsible finance. Improved consumer too limited. 14 The only realistic solution to this awareness and financial capability could help information asymmetry may be regulation with clear regulators monitor the market, as consumers and rules about price formulas and disclosure across as their advocates report abuses through hotlines or much of the market as feasible. And indeed, there other recourse channels. 14 Indeed, in the report from a recent retreat on client protection strategy in India, providers and their associations called for regulators’ support to improve enforcement of the associations’ codes of conduct. See Microfinance India Summit (2011). 9 Government, financial institutions, and funders These findings are relevant to consumer awareness have roles to play in supporting gains in client and financial capability efforts in developing knowledge, skills, and ability to assert their countries that could benefit poorer and less rights. Unequal information and power mean that experienced consumers. The insights should also consumers start out at a disadvantage compared inform regulatory and industry efforts to protect to their providers. Furthermore, recent behavioral consumers against avoidable risks and design research shows how certain systematic cognitive products that consider their needs and financial biases, “rules of thumb,� and other behaviors behaviors. For example, the Central Bank of the undermine the ability of low-income clients (and Philippines recently applied these emerging lessons others) to protect themselves. The following are and used focus groups to test the clarity and some of the most important observations from effectiveness of a new draft credit disclosure form recent behavioral studies that affect responsible with low-income financial consumers. The form finance at the base of the pyramid: 15 was redesigned to make it easier for consumers to understand costs and key terms, compare similar • Consumers tend to discount greatly the future for offers, and make informed financial decisions. the present, known as hyperbolic discounting. This can be seen in credit products where consumers Developing country governments are focus more on the allure of up-front cash than the demonstrating a keen interest in taking action on interest and other costs they have to pay over the this front. Often, financial sector authorities play life of the loan. the roles of convener, champion, and overseer • Consumers tend to underestimate costs of of consumer awareness and financial capability financial products and overestimate their potential efforts, while mobilizing support from industry for success (and in turn their capacity to repay). In and other public- and private-sector players to the case of low-income microentrepreneurs, this experiment with how best to improve consumers’ could lead them to borrow at a higher cost than financial knowledge, skills, and decision making.16 expected, while also anticipating greater future Interestingly, of the more than 400 MFIs that revenues than are likely. As a result, they could be completed the MIX social performance report, at greater risk of becoming over-indebted. 38 percent stated that they offer some type of • When facing decisions on complex or confusing financial education to clients (although this group is products, such as financial services, consumers likely to comprise more socially oriented providers often use overly simple calculations and base their and not be representative of MFIs as a whole) decisions on erroneous conclusions or assumptions. (Pistelli, Simanowitz, and Thiel 2011). Early lessons For example, one respondent in a focus group of from this work include the need to tailor strategies Mexican consumers described how he compares to different segments (e.g., in-school youth, the total cost of a consumer loan with the amount formal sector employees, older people, etc.) and of cash he will receive up front. His rule of thumb complement classroom education with awareness- is that the loan is a good deal if the total cost is no raising campaigns and nontraditional approaches, more than twice the proceeds. such as “edu-tainment� through soap operas and • Consumers often tend to choose products where popular media. Funder interest is growing at the approval is fast, reliable, or easy, even if the product national, regional, and global levels, including in question is more expensive or less favorable support for research on financial behavior and than alternatives where the client perceives that capabilities of low-income consumers, partnerships approval is less certain. with financial institutions, and policy advisory work. 15 See, e.g., Barr, Mullainathan, and Shafir (2008); Dawnay and Shah (2005); and Krishnan (2008). 16 See, e.g., government-promoted initiatives in Brazil, Kenya, and Indonesia. The International network on financial education, facilitated by the organization for economic Co-operation and Development, convenes governments working in this area to share emerging good practices and articulate principles of effectiveness. 10 Of the three lead strategies, the state of framework developed through consultation knowledge and practice are most limited in among practitioners, funders, networks, technical the areas of consumer awareness and financial assistance providers, rating agencies, and capability. It is unclear what will work, how, and researchers. Four specialized microfinance ratings for whom, especially in low-income markets. The agencies conduct social ratings, more than 120 of conversation has just begun about the respective which the Rating Initiative funded in 2008–2009. roles of government, industry, civil society, and consumers themselves. Little is known about Social performance data reported thus far show consumer perceptions and behavior (especially that an MFI’s ability to collect and report social for consumers in developing countries) and how performance data correlates strongly with the product design, regulation, or consumers’ own level of market maturity and competition, social knowledge and skills might overcome behavioral performance training provided to its staff, and biases that put consumers at greater risk. Research investors‘ demand for such data. MFIs have on these issues could go far to inform industry and made the most progress in measuring client policy initiatives. It will also shed light on how to retention and integrating social performance design and implement specific interventions to into staff performance appraisals and incentives. improve consumer awareness and capability. Weak areas include monitoring of client poverty levels and ongoing market research to improve Strategies to improve products and processes (Pistelli, Simanowitz, and social performance Thiel 2011). Half of the MFIs reporting to MIX offer nonfinancial services specifically designed for needs For most service providers who have a social of female clients. Reporting on client outcomes mission, responsible finance extends beyond client is still at a very early stage, with few MFIs able protection to the commitment to actively measure to assess with precision whether they are meeting and manage their double bottom line. The vision their stated goals. For example, while 84 percent of here is that the many players in the microfinance MFIs reporting to MIX indicated they had a goal of market with social missions first apply improved poverty reduction, only 10 percent had systems in metrics for assessing client outcomes, and then place to track client progress out of poverty. act on the findings by adapting their products and methods to better address clients’ vulnerabilities The global Social Performance Task Force and life-cycle needs. This objective is advanced (SPTF) includes practitioners, funders, networks, by social performance awareness and training technical assistance providers, rating agencies, initiatives for staff and integrating both bottom and researchers. It serves as the information hub, lines into staff performance appraisals. The drives standards development, and coordinates governance dimension is also coming into sharper industry-wide consultation to ensure that focus, including the Board’s role in ensuring the standards are practical and adapted to the realities provider stays on course in balancing financial and of delivering financial services to the poor. SPTF social performance. is in the process of developing a set of universal standards for providers that establish clear The industry has made solid progress in expectations on social performance management developing social performance metrics, tools and reporting. These cover client protection and for client targeting, and independent audit and other areas, such as social goals and target clients, ratings methodologies that assess a provider’s governance and staff commitment to social goals, entire business process against its intended client client-responsive products and services, client outcomes. In just two years, more than 400 MFIs monitoring, responsibility to staff, and responsible (representing 40 percent of MIX reporters) have financial performance. Providers are applying submitted public (self-reported) data on their lessons emerging from the rich social performance social performance, using indicators and a common management experience, as they seek to better 11 segment demand, diversify product offerings, ensure quality, and increase client benefit. Box 5. Integrating Social Performance Management into Operations at AMK, Cambodia Role of Funders in Promoting Responsible Finance AMK is a fast growing MFI that serves the largest number of clients in Cambodia. It has cultivated a strong social performance culture and integrated Donors and investors play an important role in management for its double bottom line throughout accelerating uptake of client protection and social its strategy and operations. The Board-level Social Performance Committee oversees reporting from performance management by supporting all the management that integrates social and financial strategies. They can create the right incentives metrics. by funding providers that have missions aligned with their own and that adhere to emerging good The Research Department serves management with information, including an annual client survey.a practices. As standards and benchmarks develop, The findings feed into a holistic index of household funders that finance retail providers directly have well-being for AMK to assess client poverty status begun to screen for acceptable practices and to and track impact over time. AMK’s leadership views the benefits of the strong internal research function support partners to address responsible finance it has created to be well worth the investment. The weaknesses.17 research has contributed to new product design and delivery methods, examples of which follow: Funders also can provide stronger performers • Scoping studies helped estimate demand for with more financing, financing on better terms, or new products (individual loans, remittances, visibility. Several social investors now offer such deposits). financial incentives (see Box 6). To encourage use • Client profiles helped AMK design its credit line of social performance tools and MIX reporting, product, including loan ceilings. • Client cash-flow information helped AMK better several funders collaborated to offer a global plan its own cash flows and demand patterns. social transparency award. Others backed a • Exit surveys highlighted problems, such as the regional social performance award that offers a need to communicate better on or eliminate the monetary incentive and recognition process for practice of charging daily interest. • Satisfaction surveys highlighted what clients Latin American MFIs that meet higher standards of particularly valued (such as credit officers’ accountability for their missions. Beyond providing respectful behavior), gave feedback on product technical assistance and grants at the retail level, and process suitability, and fed into training for new staff. donors (and some investors) also are funding the • The internal audit function kept a check on client Smart Campaign, MFT, SPTF, and other initiatives protection practices. that provide industry-level “market infrastructure� a Client-level information includes household profiling for responsible finance, through standards (members, livelihoods); household cash flows and seasonality; development, tools, and validation processes. 18 financial transactions, including use of other financial services (informal, other MFI), extent of indebtedness, and savings; Another constructive development is collective loan use; poverty assessment; and client satisfaction (likes and action by investors to identify markets at risk of dislikes about AMK, compared with alternative providers). Note: Drawn from Imp-Act Case study in Social Performance overheating and to take preventive action.19 Resource Centre, http://spmresourcecentre.net/index.cfm/ linkservid/89852517-DD4D-4144-827D9E42C793805D/ showMeta/0/. Funder roles are not limited to working directly with providers and industry initiatives. Development 17 CGAP worked with the investor community to develop detailed guidance on integrating client protection concerns at every stage of the investment process. The latest guidance document includes a “due diligence� checklist with 12 core areas of investigation that investors can adapt to their own due diligence process. See forster et al. (2010). 18 The MicroCredit Summit Campaign is spearheading creation of a Seal of excellence for Poverty outreach and Transformation in Microfinance. The Seal would recognize superior performance by sustainable MfIs with this social mission that achieve significant scale of service to poor clients and demonstrate strong commitment and a strategic approach to transformation of clients’ lives and poverty reduction. 19 See Kappel, Krauss, and Lontzek (2010). 12 Despite progress over the past few years, however, Box 6. Donors and Investors Stepping much remains to be done. There are significant Up on Client Protection and Social Performance gaps in knowledge and practice surrounding each of the three lead responsible finance strategies. • Incofin developed a dashboard (called ECHOS) Discussion is just getting underway on important to score potential investees on 43 environmental and social performance indicators during due new dimensions of responsible finance in our diligence. A score below the cut-off set by policy sector, such as growth management strategies, results in automatic rejection of the investment profit levels and allocation, and proactive proposal. governance for the double bottom line. Pioneering • Oikocredit provides a premium to investees that show good social performance, using a first-generation products and methodologies scorecard on the institution’s environment, social, in microfinance are evolving to enhance client governance (ESG) profile. The “extraordinary outcomes and sustainability. As new products social relevance discount� is a reduction of 0.25 and channels come on line, responsible finance percent to 1 percent off the negotiated rate, depending on how an organization scores on considerations can be built in from the beginning. eight questions. When the three strategies come together, they • Since 2010, the United Nations Capital will create stronger incentives across the board for Development Fund performance-based agreements reference CPPs, and the agency has microfinance as a long-term relationship business identified quantitative indicators to track retail that delivers shared value for client and provider. providers’ progress on the two dimensions of responsible finance. In the longer term, evidence about the business case for responsible finance will be critical to widespread adoption of improved practices. agencies and donors often support consumer Further research is needed to document potential protection policy processes with diagnostics, trade-offs and test specific premises about how technical assistance, and capacity building. doing right by one’s clients is good for business. They are also contributing to progress in market infrastructure, such as credit information sharing, Client protection and social performance are and are playing an important role in advancing at different stages in the journey from initial knowledge and practice on practical approaches development of guiding principles, to application to improve consumer awareness and financial of commonly accepted standards, to transparent, capability. universal reporting, and ultimately, to benchmarks for improved practices. Global efforts, such as the Smart The Way Forward Campaign and SPTF, amplify action by retail providers and play a key role in advancing responsible finance We see clear progress on each of these strategies to and facilitating the frank industry-wide discussion advance client protection and social performance. that is needed to maintain momentum and deepen This progress is building awareness across the implementation. Good practice examples and new microfinance sector about the role of responsible tools are needed, including for noncredit products, finance in delivering stronger value for clients and such as microinsurance. The sector’s reputation will ensuring the long-run viability of providers. Industry also hinge on success in verifying actual practice leaders understand the operational, reputational, against emerging standards, particularly through regulatory, and political risks from failure and third-party certification by raters and auditors that is agree that action on responsible finance is the right being developed by the Smart Campaign and SPTF. thing to do and reflects the core business values of the great majority of market players in our sector. Donors and social investors will continue to play Balanced management of financial and social important roles for some years to come in many performance and accountability for client benefit markets and for many providers. To the extent they are important for market development, the sector’s align their financing to create the right incentives, credibility, and its ability to finance growth. advances in responsible finance will be faster and 13 more widespread. This requires further integration Campaign, SPTF, and funders agreed on and began of responsible finance into due diligence and implementing CPPs in the space of just a few years. reporting processes, as well as clear policies to Transparency efforts exhibit close collaboration reward strong performers and turn down providers among providers, regulators, and international with inadequate practices. organizations, such as MFT. Particular care must be taken to communicate clearly with retail providers In January 2011, more than 40 microfinance about these initiatives, set realistic expectations investment organizations came together in a about the pace of implementation, and work to responsible investment initiative, launching the keep compliance costs manageable for those at the Principles for Investors in Inclusive Finance (PIIF) front line of responsible finance. Funder support under the umbrella of the United Nations Principles for the change management process at the level of for Responsible Investment (UNPRI). PIIF commits the retail provider is helpful, as is streamlining of endorsers to fund responsible retail providers and tools and processes (e.g., the planned rating tool try to create the right incentives for their investees reduces costs and time demands for providers by to treat clients appropriately. They specifically combining financial and social performance metrics incorporate the Smart CPPs and the SPTF social in a single standardized tool). performance management principles. PIIF underscores the need for more active engagement The vision of responsible finance is compelling. throughout the investment process, including Working together, hundreds of microfinance in governance. Mirroring a trend in the broader providers, networks, funders, and policy makers investment world, endorsers also commit to fuller are charting the path toward models of financial integration of ESG criteria into investment decisions services delivery that can provide a powerful and reporting. 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Washington, D.C.: CGAP. http://www.cgap. paper or others in indicators%20mar2011.pdf org/p/site/c/template.rc/1.9.47443/ this series. SPTF Briefing Notes on making the case for SPM. Financial Inclusion Regulation Center. http://www. CGAP welcomes your comments on http://www.sptf.info/resources/making-the-case- cgap.org/p/site/c/regulation_center/ this paper. for-spm Porteous, David. 2009. “Policy Focus Note 2: All CGAP publications World Council of Credit Union Consumer Consumer Protection in Credit Markets.� Financial are available on the CGAP Web site at Protection Principles. http://www.woccu.org/ Access Initiative. http://www.microfinancegateway. www.cgap.org. bestpractices org/p/site/m//template.rc/1.9.41468 CGAP Policy Makers World Bank. 2011. “Good Practices for 1818 H Street, NW MSN P3-300 Financial Consumer Protection.� Consultative Washington, DC Alliance for Financial Inclusion. 2010. “Consumer Draft. Washington, D.C.: World Bank, 20433 USA Protection: Leveling the Playing field in financial March. http://siteresources.worldbank.org/ inclusion.� Policy Note. AFI, January. http://www. EXTFINANCIALSECTOR/Resources/Good_ Tel: 202-473-9594 Fax: 202-522-3744 afi-global.org/en/policy-solutions/consumer- Practices_Financial_CP.pdf protection Email: World Council of Credit Unions. 2008. “Model cgap@worldbank.org Brix, Laura, and Katharine McKee. 2010. “Consumer Regulations for Credit Unions.� Madison, Wisc.: © CGAP, 2011 Protection Regulation in Low-Access Environments: WOCCU. http://www.woccu.org/bestpractices/ Opportunities to Promote Responsible Finance.� legreg Focus Note 60. Washington, D.C.: CGAP. http:// www.cgap.org/p/site/c/template.rc/1.9.42343/ Consumer protection resources. http://www.cgap. org/p/site/c/template.rc/1.11.6053/ The authors of this Focus Note are Katharine McKee, Estelle Ehrbeck, Mayada El-Zoghbi, Rafael Mazer, and Jeanette Thomas Lahaye and Antonique Koning of CGAP. Gregory Chen, Tilman of CGAP reviewed the paper and contributed useful insights. The suggested citation for this Focus Note is as follows: McKee, Katharine, Estelle Lahaye, and Antonique Koning. 2011. “Responsible Finance: Putting Principles to Work.� Washington, D.C.: CGAP, September.