UNIVERSITE LIBRE DE BRUXELLES

EUROPEAN MICROFINANCE PROGRAM 2015/2016

HowcanweavoidMissionDriftinMicrofinance?

Adele Voyeux

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I.Introduction:

As yunnus well said it, access to credit should be a basic human right. Microfinance provides

it to the unbanked poors, and can thus be considered as a “progressively ethical activity”

(Villaamil, 2015).

Unfortunately several crisis’ followed by many suicides occurred in the microfinance industry,

that made many academics and the media requestion the ethicality of its activities (Hudon &

Sandberg, 2013). The confrontation between the moral values and the economic imperatives

is now clearly observed, and the microfinance industry is under the threat of experiencing an

“Ethical Crisis” (Villaamil, 2015).

This crisis can mainly be explained by the new tendency of MFIs to transform themselves

into regulated bodies. According to the CGAP (2001), excessive commercialization is a great

danger as it can develop an overpreocupation with profitability and lead MFIs to trump good

banking practices at the expense of their social goals. There is thus an increasing risk of

mission drift in the industry, which strongly damages the industry’s reputation.

It is important to notice that the MFIs that stayed the longest on the market, are the ones that

are the most mission fulfilling (Armendariz & Szafarz, 2011). However, there are many

internal and external factors that can increase the tension between the desire to maximize

social impact and the desire to increase profits, leading to a confusement and a loss of focus

on the original goal of alleviating poverty.

In the first part of this essay, we will study what is exactly mission drift, its importance and

how it emerged in the microfinance world. In the second part, we will explain how an MFI, by

implementing internal management processes, can avoid mission drift. Moreover, we will

see that mission drift is not a phenomenon that needs to be fought only at the MFI level, but

from the whole industry: donors, investors and regulators also have a role.

II.WhatisMissionDrift?

Mission drift is a truly redouted phenomenon causing real damages to the Microfinance’s

public image (Armendariz & Szafarz, 2011). Mission drift is a term given when an MFI

deviates from its original mission of alleviating poverty by servicing the poorest of the poor;

moving in a new direction where its desire for profitability exceeds its social objectives

(Opportunity International, 2007). In this essay we believe that Microfinance and therefore all

of the MFIs have a general mission of alleviating poverty.

The recent loss of reputation in the Microfinance industry didn’t stop it from growing, and it is

now experiencing a 15-20% annual growth (Etzensperger, 2014). As the industry is rapidly

expanding, and competition is kicking in, MFIs also need to evolve by scaling up and

become more efficient. To be able to grow at a significant level and benefit from economies

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of scale, they need a substantial amount of funding, and the usual donations are not enough.

MFIs therefore need to identify new financing strategies to stay on the market (Ghosh, Van

Tassel, 2011). With this in mind, the usual MFI will decide to transform itself into a regulated

body, in an attempt to raise funds from private investors (Charitonenko et al., 2003).

Transformation can bring many advantages to an MFI. Transformation changes the MFI in

two ways: they become regulated by the banking authorities; and they move from a self

owned NGO to shareholder owned organization. Regulation is a great advantage for an MFI,

as it enables them to collect deposits (Staschen, 2003), which are a very cheap source of

funding. Moreover, as they are regulated, they attract more easily the external investors.

They can thus be funded from the commercial market, grow faster, and benefit from

economies of scale. With economies of scale, the cost per loan decreases, making the MFI

more efficient and augmenting its profits (Kar (a), 2013). Shareholder ownership can also be

favorable, as it can improve the management, and hence the efficiency (Mersland & Strom,

2008). Managers need to answer to the owners, making them feel more responsible.

The advantages are not just financial. With economies of scale and its benefit of lower

transaction costs, MFIs can reach poorer clients, and hence therefore increase their depth of

outreach, as well as breadth. As a result, if transformation is well performed, it can improve

the financial but also the social objectives of an MFI (Kar (a), 2013).

In the transformation process, it is believed that it is the regulatory status and the ownership

one that make the MFI more efficient, however after some studies, it has been found that

they have no strong effect on the sustainability and outreach of an MFI (Merlsland & Strøm,

2008; Hartarska & Nadolnyak, 2007). It is the saving status that has the biggest influence.

Eventually, as an MFI grow, it will need to collect deposits. Many MFIs will thus transform

now, thinking of the future. In other words, they are investing in growth, to ameliorate

themselves in the long run. This might mean, socially, to mobilize resources in the short term

and lower social performance, however with the idea of enhancing it in the future. Managers

are diminishing their current social performance, because they have a preference for what is

possible in the future (Copestake (b), 2007).

Transformation is very expensive, and staying sustainable without receiving any donations

can be very hard. MFIs have a pressure to quickly scale up and expand their outreach to

stay financially efficient (Epstein & Yuthas, 2011). Small loans are costlier than larger loans.

Having this in mind, MFIs might start servicing wealthier clients to be viable. This fear of

staying sustainable, or even the new taste for higher returns might lead to an over-

preoccupation with profit at the expense of their social mission. As a result, if transformation

is not well performed, it is one of the main drivers of mission drift. This loss of focus in the

mission is difficult to recognize as the mission statement of the MFI may not change per se,

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but the profession does. In other words, their activities and their target clients are remodeled.

Average loan size can be used to observe this phenomenon (Cull et al., 2007). The bigger is

the loan size, the wealthier is the targeted client, and thus the smaller is the depth of

outreach of the MFI. However the issue with this proxy is that the loan sizes in an MFI might

increase due to other reasons. Giving out larger loans is not only driven by the transaction

cost minimization (Armendariz & Szafarz, 2011). There are many other factors that might

oblige the MFIs to increase it, and therefore drifting from their mission.

Firstly, the average might differ from countries. Microfinance’s aim is to alleviate poverty by

reaching the unserved. In some areas of the world, the financial sector is less developed,

creating a larger amount of unbanked individuals. In these situations, the MFIs usually have

wealthier clients as they serve the unbanked, not just the poorest. For these reasons in Latin

America, the average loan size in higher than in Asia, and this doesn’t necessarily mean that

they are drifting from their mission (Armendariz & Szafarz, 2011; Kar (b), 2010).

Secondly, the stream of subsidies given by the donors is not always constant, creating

uncertainty within the MFIs. MFIs might decide to increase average loan size, or interest

rates charged, as a precaution, if they do not receive any subsidies in the times to come

(Armendáriz, D’Espallier, Hudon, & Szafarz, 2011).

Thirdly, as they grow, they need to raise funds from the commercial market. Most of the

time, they are profit maximiser investors that expect a certain kind of return (Mersland,

2009). MFIs might thus decide to put forward their financial mission in the aim of attracting

them. We can notice that in the last two circumstances, it is the donors and the external

investors that trigger the mission drift phenomenon.

Finally, there is a very thin line between mission drift and cross subsidization. The average

loan size might increase because of cross subsidization. This is done with the aim of

financing the poorest with the return made with the richer clients. Moreover, progressive

lending can be another reason for an increase in the average loan size (Armendariz &

Szafarz, 2011).

It is therefore very difficult to judge if there is mission drift or not, only by looking at the

average loan size. Other proxies can be used, to complement the analysis, such as interest

rate charged or percentage of women in the portfolio to assess the depth of outreach of an

organization and therefore their social performance (Bhatt & Tang, 2001).

However if the usual trend is for the MFIs to transform themselves, there is a huge risk of

mission drift. It is therefore crucial to make sure that the MFIs are not drifting from their

mission and find specific mechanisms that can help them remember their original mission.

Microfinance needs to alleviate poverty.

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III.HowcanweavoidMissionDrift?

In this section some main recommendations are given to any top MFI manager, in the aim of

avoiding the experience of mission drift, and regain focus on the mission. Recommendations

are also given to other actors and drivers of mission drift, such as the donors, investors and

regulators.

At the MFI level mission drift can be escaped by developing a comprehensive internal

system of management that will help an MFI to recognize the warning signs when it loses

focus on its mission, and take the necessary actions (Epstein & Yuthas, 2011). Implementing

an entire Management system is complex and needs to be done in different stages and at

different levels of the MFI.

First of all, before any MFI is created, it needs to make sure that it has a clear, attainable

and motivational mission. This usually begins with a mission statement, guide to any

decision made by or in the organization (Jonker and Meehan, 2008). To make sure that the

organization is not loosing focus, clarity and direction can be enhanced with an “Intended

Impact” statement. This statement describes the benefits the organization is trying to seel

and identifies the targeted population (Bradach et al. 2008). With this, a “Theory of Change”

must also be developed, helping the MFI step by step in determining the processes through

which the impact can be achieved. These stages of action are then made more concrete

through specifications and quantifications of actions and outcomes, helping the employees in

better understanding them (Epstein & Yuthas, 2011). However this last stage can’t be done if

the actions and outcomes are not measured and assessed.

Second of all, any MFI requires a good performance measurement system. MFIs are hybrid

institutions with a financial but also a social mission. It has long been recognized that it is

very difficult to measure the success of an organization that has a double objective (Drucker,

1990; Forbes, 1998). This is mainly because it is extremely hard to measure poverty.

However, to make sure that they are well attaining both their goals, some social qualitative

indicators should also be included as a complement to the existing quantitative indicators

(Copestake (a), 2007). Determining these indicators and measuring social performance is

can be expensive (Khandler, 1998; Morduch, 1998). The social performance task force

website (2011), already developed some rating systems and methodologies that can be

easily implemented in the industry and the SPI4 (Social Performance Tool developed for the

MFIs by Cerise) can be used by the MFIs themselves at no acquiring cost. Measuring well

performance is crucial and should be done routinely, to reveal any internal problem. To stay

true to their mission, MFIs should only respond to their internal demand, and not the

pressure from the external organizations when taking decisions (Copestake (b), 2007).

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It is also very important to make sure that there is a good communication within the

organization. We need to make sure that everyone well understands the mission and is

acting according to it. To do that the mission statement as well as the performance

measures need to not only be communicated to the employees but also explained. The

employees therefore know what they actually need to ameliorate within the organization to

improve the MFIs performance (Aubert, Janvry, & Sadoulet, 2008). Moreover to make sure

that the employees are working with the intention of the MFI and not their own, a sense of

strong responsibility towards the MFI, or incentives, or trust between the MFI and the

employees can be installed. Firstly, it is important that the incentives are not solely based on

repayment, but others that can also rise the social performance of the MFI, such as

implementing audits at the level of the credit agents making sure they select potential poor

borrowers in accordance with the MFIs objective (Aubert, Javrty, & Sadoulet, 2008).

Secondly, responsibility can be given by counting the employees opinion when decisions are

made in the organization. Thirdly and finally, trust is very important. Employees need to be

sure that the MFI wants their good, and not rip them off (Amin, 2014). There is also trust

between the clients and the MFI, otherwise the clients wouldn’t have accepted to take a

loan, they must believe that the MFIs are here to help them, and not take advantage of them.

However mission drift is destroying this trust, as the MFIs are not acting according to their

original mission of alleviating poverty that they promised to their clients, and taking

advantage of them, seen as the vulnerable party (Amin, 2014). Violating the trust of their

clients adds to the unethicality of mission drifting.

Third of all, MFIs also necessitate a good governance mechanism. The board of directors

should well understand the importance of the social objective of microfinance, and don’t

forget to include them in their decision-making. They can implement periodical social audits

or the support of client activism (Arena, 2008). These mechanisms are expensive and a cost

benefit analysis has to be conducted by the managers (Epstein & Yuthas, 2011). It is also

important to have an efficient board of directors, as they can avoid mission drift. In other

words, an MFI starts increasing its loan size, or its interest rate charged, when it is

experiencing financial difficulties, and if the board is well composed, they can make sure that

the costs per loan doesn’t increase over time, and therefore no need to mission drift. Better

management can therefore be realized, by focusing on trying to reduce the costs per client

and not on “commercialization”. The industry is still growing strongly, and there is therefore

still a lot of room for cost reduction (Mersland & Strom, 2010).

Fourth of all, it is also important to design and innovate in the aim of moving the industry

forward, and ensure their ongoing effectiveness (Epstein & Yuthas, 2011). The market is

changing with the quick growth of the industry, and the MFIs must adapt themselves to stay.

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This is why they need an in house research department that can help in innovating new

methodologies or mechanisms. These should of course always be in line with the MFIs

mission. MFIs also need to consider being open to paradigm such as: implementing new

technology devices, or not only serving women.

Finally, MFIs are not the only ones to blame for the threat of mission drift in the industry.

Some external actors or factors can have a strong influence on the decisions taken by the

MFIs, making them deviate from their mission.

First, MFIs can’t survive if they don’t receive any funds from the exterior. MFIs can either

receive commercial funds or subsidies. On one hand, the commercial funds are most of the

time provided by profit-oriented investors (Gosh-Van Tassel, 2008). To attract them, MFIs

are obliged to increase their profits at the expense of their social mission. MFIs should

therefore try to target more socially responsible investors and if not possible, external

investors on their side should augment their social target in the conditions given with the

loan. This is very important to make sure that the whole industry is staying true to its mission

and not disappearing.

On the other hand, the subsidy uncertainty can also create a certain type of mission drift.

MFIs will increase either their interest rates or their loan size in order to build precautionary

savings under the fear that subsidies can dry up (Armendáriz, D’Espallier, Hudon & Szafarz,

2011). The MFIs are just acting according to their needs, created by the donors in this case.

Nonetheless, subsidies can be a huge help for the MFIs in reaching their social mission, as it

can reduce their costs and thus decrease the interest rate charged and reach poorer

households. If the volume and timing of subsidies are designed in a less uncertain fashion

by donors, they can have a stronger impact on the MFIs poverty reduction mission. However

there is of course a risk that subsidy are used inefficiently by the MFIs if they can receive

them easily (Bhutt and Tang, 2001). According to Hudon and Traça, Subsidies have a

positive impact only up to a certain threshold. To avoid mission drift in the industry, the

donors therefore have to provide a constant and optimal amount of subsidy to the MFIs,

allowing them to increase their efficiency and their mission fulfillment, and not facilitate

procrastination.

Second, Mission drift will also depend on the context of the country in which the MFI is

operating. In some countries the regulations are practically non-existent, even if the

microfinance industry is well implemented. In other words, the MFIs can operate as they

want with no real restrictions. This unregulated environment can of course lead to an

increase in the financial performance of the MFI, such as banco compartamos in Mexico, but

in term of social performance, there is no improvement, and the risk of mission drift

tremendously increases. It can be argued that regulation can be beneficial for the fight

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against mission drift and help the MFIs to act more ethically (Villaamil, 2015). After the crisis

in Andra Pradesh, the government decided to strengthen the regulations on microfinance in

the area. At first, this led to a positive decrease in the interest rates charged, however as the

regulation was too strict and theorem negatively affecting the financial and social

performance of the MFIs, they decided to decrease even more their interest rate with the aim

of reaching more clients and poorer ones, however this lead to a huge reduction in the

repayment rates. The argument is therefore valid, as long as the regulations are not too strict

or too tight (Villaamil, 2015).

IV.Conclusion:

Microfinance declared to the whole world that its main aim is to alleviate poverty by servicing

loans to the poor unbanked individuals. By affirming this, the Microfinance institutions

created a special trust with their clients whom believe that the institutions have a social

objective alongside their financial one, and are therefore not exploited.

Nowadays, microfinance is under the threat of experiencing an “Ethical crisis”, as there are

more and more institutions drifting from their mission. There is the fear that microfinance is

starting to take advantage of the vulnerable party being the clients, and that the investors in

the industry are the ones receiving money in their pocket, destroying the ethical dimension of

microfinance. With commercialization, microfinance might be loosing its true purpose of

alleviating poverty, and in the long term the trust it had with its clients.

It is therefore crucial that the whole industry understands the importance of this treat, and

takes measures to avoid mission drift and regain clarity on its original mission. In this essay,

it has been argued that profit can be addictive and needs to be resisted at the MFI level but

also at the whole industry one. MFIs can therefore implement some processes that will help

them remember their social mission, such as having an apparent mission statement, good

social performance indicators, and constant performance checks. However sometimes the

MFIs deviate from their mission not only because of a thirst for profit, but because they are

obliged to. To be able to grow, and stay on the market, the MFIs need funding, that can only

be found on the commercial market or met by deposits. MFIs will thus decide to transform,

and alongside this process loose focus on their mission. The industry therefore has to

contribute to improve the social mission of the MFIs by for instance providing better-

scheduled subsidies, having more social performance requirements from investors, or even

fairly regulate the industry.

The beauty of microfinance is that it created a social side to finance. It will be a shame to

see a whole industry disappear, and be replaced by profit-oriented organizations, when there

are already plenty of them in the world.

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