> Posted by Bobbi Gray, Research and Evaluation Specialist, and Kathleen Stack, Vice President, Programs, Freedom from Hunger

Recently, Dean Karlan published an article in the Stanford Social Innovation Review titled “The Next Stage of Financial Inclusion.” The key points of his article are that while non-profits led the way in developing microcredit for the poor and started the movement for financial inclusion, for-profit companies have increasingly found it worth their while to offer financial services for the base of the pyramid. The entrance of new players to the market, Karlan offers, is a testament to the success of the early microfinance-focused non-profits. However, Karlan suggests that non-profits still have an important role in continuing to innovate in the financial services space. We agree. This is particularly true for extending financial services to people that banks still consider unprofitable: “the too rural, the too poor and the too young.” We would add disabled populations and the “too old.”

Recently, Rupert Scofield, CEO of FINCA International, acknowledged the role that new credit providers and technologies are playing in the industry and how their entry into the market is changing how established microfinance organizations must now work to remain competitive. Scofield’s perspective, shared in a piece in The Guardian, is that this is a “positive disruption, from the perspective of the clients, and that’s the most important thing because it’s lowering their transaction costs, it’s making their lives easier in the sense that it’s easier for them to deal with financial institutions and to move money around.”

When we consider these realities with all of their challenges and opportunities, a few points seem important to highlight.

1. Government regulations determine whether institutions can experiment with services for marginal clients, especially non-financial services

In some countries, for example, financial regulators create interest-rate caps that can penalize organizations that are trying to innovate. Over the past several years, Freedom from Hunger has seen an increasing number of microfinance organizations offer or promote other development services designed to meet their clients’ needs. This has been valuable for clients, and also a way for providers to distinguish themselves in an increasingly competitive marketplace.

While responsible microfinance providers all agree that not overcharging the poor for financial services is important, interest-rate caps and other regulatory measures have forced some highly successful microfinance institutions (MFIs) to split into two entities: a formal financial institution or bank and a non-governmental organization (NGO). In this model, profits from the financial institution “bank” fund development services that are offered through the NGO. Making this kind of transformation is tricky, and costly and takes time, but it can also free the institution to innovate without restrictions. It is important to note, however, though that this approach is only feasible for mature organizations that can afford to invest in establishing a second organization.

“Unified services” are often more cost-effective, since the cost of providing the financial service can subsidize the marginal costs of the development services. Excessive regulation, therefore, can really hurt smaller and newer organizations that are trying to provide unified financial and development services under one roof. They are forced to choose financial services over the other services. As a result, the opportunity to provide development services to the poor in areas where they do not yet exist or are inadequate is often lost.

2. Financial institutions’ new interest in savings groups

As Karlan points out, savings groups have proven an important innovation for reaching very rural areas. They are helping to expand outreach as well as improve client outcomes.

Interestingly, we’re seeing more interest in savings groups from formal financial providers, such as credit unions and MFIs. They are increasingly recognizing the business case for organizing groups and designing savings products for them as part of their portfolio of services. This is an exciting opportunity, particularly with the advent of new technologies that can link savings groups to bank accounts.

Similar to their interests in serving the financial needs of young people, financial institutions see savings groups as a way to bolster their pipeline of future clients. NGOs are playing an important role in testing linkage models and in the direct provision of services to savings groups in underserved markets.

3. “Hybridity”

Karlan recommends that non-profits have an important role in continuing to innovate in the financial services space, but should focus primarily on extending financial services for the most rural areas, the extreme poor, and to young people.

Yet, some of the best innovations that hold the most promise for the unserved and underserved have come from successful financial institutions—not NGOs—that have sought to combine a social mission with financial performance and have thus remained effective enough to support innovation. This suggests a hybrid approach that combines innovating with mainstream financial institutions that possess a strong social mission, while also identifying new organizations and new strategies to reach and serve the unserved and underserved poor.

4. The promise of “collaborative marketing”

MFIs have become and can continue to be effective brokers of development services for the poor.

While some MFIs directly provide development services, they can also effectively link their clients to other services offered by other organizations. This can be done at a very low cost to the MFI and provide considerable value to the client. Such arrangements have included partnerships between MFIs and national health insurance schemes as well as linkages to health and agricultural organizations. These cross-sector collaborations can support the needs of the poor more comprehensively while also helping to meet the business and social goals of MFIs.

5. Self-regulation is necessary for institutional betterment

Karlan highlights the challenges inherent with self-regulation efforts, such as the Smart Campaign certification for ethical treatment of clients, the Truelift certification for pro-poor organizations, and the Universal Standards for Social Performance Management. Self-regulation cannot always be trusted, especially in the absence of third-party verifications. There are incentives for assessed organizations to “lie” or not be completely transparent. At the same time, self-regulation is a necessary part of the picture, a mechanism to hold ourselves accountable for the goals we’ve set together. Self-regulation, when supported and followed with good intentions, is meant to improve performance and should not be discounted, even as some might question inherent biases. A justice system is only useful when extreme cases force decisions. Until then, we can only rely on internal standards of ethical behavior; social performance initiatives are playing an important role in driving this.

As a sector, financial inclusion non-profits are at a crossroads, amid sweeping shifts in the way banking is conducted globally. It is imperative that our shared social mission continues to drive our efforts. This is ultimately what distinguishes us among the expanding rank of those in financial services.

In his book, Better, Atul Gwande highlights the challenges within the medical industry that are also applicable to our own context. He maintains that:

“Better is possible. It does not take genius. It takes diligence. It takes moral clarity. It takes ingenuity. And above all it takes a willingness to try….Be willing to recognize the inadequacies in what you do and to seek out solutions…In the end, no guidelines can tell us what we have power over and what we don’t. In the face of uncertainty, wisdom is to err on the side of pushing, to not give up. But you have to be ready to recognize when pushing is only ego, only weakness. You have to be ready to recognize when the pushing can turn to harm. In a way, our task is to ‘Always Fight.’ But our fight is not always to do more. It is to do right by our [clients], even though what is right is not always clear.”

This is our moral imperative.

Have you read?

Savings Groups, Mobile Phones, and a New Solution for Rural Women

What Kinds of Regulation Promote the Development of Microfinance Markets?

Can Self-Regulation Protect Microfinance Clients?

*Post title taken from Atul Gwande, Better: A Surgeon’s Notes on Performance, 2008, New York: Picador.