Five Questions about SRI – The Case of Microfinance Revisited – Weekly Expert Interview with Arvind Ashta, Holder of the Banque Populaire Chair in Microfinance, Burgundy School of Business, Dijon, France – April 19, 2013

Each week Emerging Markets ESG publishes an interview entitled, “Five Questions about SRI.”  The interview features a practitioner’s insights about SRI in emerging markets and through Emerging Markets ESG shares this expertise with a wide global audience.  The goals of Five Questions about SRI are fourfold:

  • To collect a catalogue of examples of SRI in practice in emerging markets;
  • To raise awareness about SRI in emerging markets;
  • To reflect on what SRI in emerging markets means to practitioners; and
  • To enable SRI practitioners in emerging markets to network with peers around the world.

This week’s interview is with Arvind Ashta, Holder of the Banque Populaire Chair in Microfinance, Burgundy School of Business, Dijon, France.

Founded in 1899, Burgundy School of Business is a leading teaching and research school belonging to the network of top French academic institutions in management.  With its deep commitment to the values of responsibility, openness and creativity, its places entrepreneurial management firmly at the centre of its teaching and research mission: to train managers ready to act as entrepreneurs in both business and society at large.  On the strength of its illustrious history, its values and its organisation, and thanks to the support of companies and institutional authorities of the Burgundy region, Burgundy School of Business has set itself:  among the top French management schools, with a strong international dimension; as a reference European management institute in the areas of expertise in which Burgundy School of Business excels; and as a major academic force in entrepreneurial management.  Microfinance sits at the crossroads of two fundamental dimensions of the school’s mission: entrepreneurial management and social responsibility. In addition to this, Burgundy School of Business can also be proud of its expertise on finance issues. The creation of a Chair in Micro-Finance in April 2009 was the culmination of a project that has enabled the school to become a leader in France in this domain with regard to research, teaching and to action in the field. The main actors in Micro-Finance are partners in this Chair: ADIE (Association for the Right to Economic Initiative), PlanetFinance, Babyloan and CERMI (European Centre for Research in Micro-finance). The Chair is also funded by the Banque Populaire de Bourgogne Franche Comté and the Fédération Nationale des Banques Populaires.  Dr. Arvind Ashta holds the Banque Populaire Chair in Microfinance at the Burgundy School of Business (Groupe ESC Dijon-Bourgogne), France. He offers courses in Microfinance and researches institutional aspects of Microfinance, technology in Microfinance, and CSR. He has taught Microfinance as visiting faculty in Chicago (US), Pforzheim (Germany) and Brussels (Belgium). He has edited a book on Advanced Technologies for Microfinance. He has a number of publications in international journals and guest edits special editions of various journals devoted to microfinance. He is on the editorial review board of Cost Management, Strategic Change: Briefings in Entrepreneurial Finance and International Journal for Technology and Human Interaction.

Emerging Markets ESG:  How would you define socially responsible investment (SRI)?

Arvind_Ashta_ DSCArvind Ashta:  This is a good question. Today, the landscape of vocabulary in this sector is full of different terms all pointing to the same basic concept. Of these, socially responsible investment has come to signify commercially profitable investments made in socially desirable sectors. However, these are not to be confused with social investments or impact investments where a trade-off is anticipated between financial returns and social returns.

 Emerging Markets ESG:  What distinguishes SRI from mainstream investment? 

Arvind Ashta:  Mainstream investments would include socially responsible investments as well as investments which are in socially less desirable sectors such as cigarettes, armaments, etc.

The expected return on an individual socially responsible investment would therefore be as high as that of a mainstream commercial investment, but the whole portfolio of socially responsible investments would have a lower return for a given level of risk than a portfolio of all mainstream investments.

Emerging Markets ESG:  Which extra-financial theme – environmental, social or governance – is the most challenging for companies in emerging markets to manage?

Arvind Ashta:  Companies in emerging markets are clearly in two camps: those fighting for survival and those that are booming. For the former, evidently, financial sustainability is the first issue before the firm can think of broader societal responsibilities. Caroll in 1979 made a nice three dimensional model, the first of which had four kinds of responsibilities. The first two are its legal and economic responsibility, and the higher two are ethical and discretionary responsibilities. In terms of these, the firms near break-even point do not really have a chance to look the ethical and discretionary considerations towards environment and society. Of course, legal aspects of governance do get covered.

However, for firms which are growing fast, evidently the next level is to engage in societal responsibility. Initially, many of these firms may decide to engage in corporate social responsible or charitable actions to build an image. They soon realize that this is not correct in terms of governance because their managers are taking away shareholder’s money and they should, if properly governed, give the money to shareholders who could then choose their own charities.

These profitable firms are often in two broad kinds: the family owned ones with a paternalistic style but where owner’s interests are kept in mind and agency problems are limited. However, the responsibility is often to the family first. Corporate Governance responsibilities are molded to suit personal interests. There are exceptions which would of course defy these generalities; furthermore these assumptions are based on my impressions rather than serious research. For example, the Tatas are considered very socially responsible in India.

The second kind are often either multinationals or started by former managers of multinationals who are perhaps more attuned to social responsibility towards their employees as well as customers.

Clearly, the biggest challenge is the environment. The reason is very simple. We can think of society only after one’s family has enough. We can think of the next generation (in a societal and not a family sense) only when one’s contemporaries have been satisfied. Since these companies are in countries which are only now emerging from poverty, obviously only a small section of society has reached the level where they can think about their fellow-men; leave alone the future unborn generations. Moreover, it’s often talk more than walk.

Emerging Markets ESG:  Which extra-financial theme – environmental, social or governance – is the most challenging for investors in emerging market companies to analyze?

Arvind Ashta:  I guess you mean from the perspective of a foreign investors situated in the developed world.

Firstly, I think you are now moving from commercial investments and socially responsible investments to social investments or impact investments. They require a different answer.

However, we can club the first two and say that commercial and socially responsible investors are investing in emerging countries to take advantages of growing (and often external shock resilient) economies as well as higher risk adjusted returns in those booming countries.

They are usually limited to investing directly into the relatively small number of companies registered on stock exchanges. Alternatively, they can invest in funds where the fund manager is in their own country and they assume that the fund manager knows what is required. In either case, they have to trust that the local stock exchange in emerging countries is taking its watchdog function seriously and that the books have been professionally audited. One problem with direct investment is that even a few million dollars invested in such a few listed firms in emerging countries drives market prices to crazy levels. Any additional investment therefore makes one analyze the governance issues first to protect the money of investors. In short, environment and social issues are forgotten. Of course, to keep investors interested, the registered firms would be interested in a good Corporate Social Responsibility (CSR) image and good media relations become essential.

The other kind of investor, often the crowd investor, is seeking to invest in social returns. He would like to get an impact bang out of his buck. Some are even willing to get no returns if the cause is good. These investors are looking beyond SRI (do no harm) and are actively wanting to do good. Here, an entrepreneur of the emerging country is aware that there is a wide variety of social investors in developed countries: some more interested in social concerns and the others more interested in environmental concerns. Today, there are entrepreneurs who are in all kinds of segments attracting like investors. In these projects, the investor is aware that his desired social or environmental concerns are looked after but he is not sure of internal (corporate) governance.

No matter which way you look, governance remains the chief concern of foreign investors owing to asymmetric information problems of adverse selection, moral hazard and legal enforcement difficulties in international transactions.

Emerging Markets ESG:  Your work has revealed some of the darker sides of microfinance, including high interest rates, suicide and stress.  What can be done to ensure that microfinance is an effective and responsible mechanism of inclusive finance?

Arvind Ashta:  I would first like to distinguish and then to clarify.

First, these are the dark sides of microcredit, not of microfinance. If other financial services (such as microequity, microsavings, micropayments, microinsurance) are supplied in a mechanism complimentary to microcredit services offered to the poor, much of the negative factors we are hearing of disappear. So, we can – at a very broad level – assume that these darker sides have emerged mostly due to a profit driven need to provide microcredit services.

Second, microcredit is a very large industry, but the most visible players (the tip of the iceberg) are those who have grown very fast and are attracting international investors and international recognition. The financial pressure to become sustainable and achieve phenomenal growth rates of over 100 % per year may be at the cost of ignoring societal concerns such as overindebtedness.

Third and this is the irony of the moneylending as well as microfinance business, where monopoly moneylenders succeed and prosper, competition actually creates problems. This is because borrowers can now borrow from multiple sources and use one to pay off the other, till s/he stretches the financial ability to repay. When there is only one lender, he knows how far to go with each borrower, but when there are many, without a perfect exchange of information, it is not possible to judge the financial repayment limits of the clients. Therefore, there is need for credit bureaux, and these did not exist.

Fourth, in such a competitive world, the survivor may well be the biggest who then gets returns to scale. So, in a world where all microfinance institutions (MFIs) are being reckless, the most reckless can grow the fastest, reinforcing the problem. This proposition would need modeling and empirical research.

Fifth, while researchers have been pointing out overindebtedness for over a decade (I only started recently), the industry seems to take notice only after the media can no longer ignore catastrophes.

Sixth, our research on suicides shows a very weak possibility, but not certain causality. We used longitudinal and cross-sectional data on India as well as multi-country basis. All this data has limitations, but it was the best available to us. Often we found weak correlation between various factors including increased suicides in men when the number of microcredit loans increase; and sometimes we found high correlation but no causal factor: for example, we found a higher correlation between male suicides and bank’s lending to poor people than with microfinance. Sometimes we found no correlation but a semi-strong factor through regression. If anything, we found correlation with male suicides; while microcredit is received by women! Moreover, in our paper we indicate clearly that based on established research it seems that suicides, especially male suicides, go up with development and this is known since Durkheim’s times in the 1870s. Other researchers have attributed the suicides to the genetically modified seeds being used by farmers in that specific region of India.

The question of high interest rates is not so easy; and has been in the forefront since the Mexican MFI Compartamos had a very successful secondary IPO pushing its valuation to $2 billion for share capital with par value of $6 million. Its valuation was driven by high growth rates which were driven by profits made by charging interest rates of nearly a 100% per year. We have always known that small loan sizes require interest rates to be higher than those for larger loans – given the need for higher monitoring and closer interaction with the clients.

However, we also know that the interest rates charged by MFIs in any country are significantly lower than those of moneylenders – the only alternative for the poor to borrow from. If the MFI rates were not lower than the moneylenders people would rather go to the latter. However, this line of argument does not justify usurious rates or justify MFIs as a ‘lesser of the two evils’ choice.

The real question is what interest rate are reasonable (given the country and economic context they work in) and how transparent the MFIs are in disclosing their costs to the clients.

These are questions for the regulator of each country to decide and place interest rate ceilings allowing a sustainable financial return for the MFI but excluding the sharks. This ceiling may be 27% in Bangladesh and some West African countries, but there is no stopping Mexico from placing it at 60%. A political actor needs to balance the interests of the lenders and the borrowers. Of course, in some countries, such as UK, “no interest rate ceiling” may be a political decision. But this decision is not appropriate for all countries. Historical research has shown that even within a country, there may be centuries of pro-ceiling followed by centuries of no-ceilings policies.

The only thing that we can definitely say is that microcredit, like all loans, causes stress on borrowers . Even a layman knows that without stress, no one repays, no matter what the culture of the country or society. So some form of stress is required to get people to repay. However, for the entrepreneur, an additional financial stress comes from financial leverage. Firms need equity as well as debt to function, and if it is too leveraged (that is, it has too much debt against its equity), it will not pass any stress test. So, in my recent research, I have been advocating micro-equity. But other kinds of microfinancial services may also be required.

Although you have not asked this question, I think it is important to think why we love the word “microfinance.”  What does it connote to us? What do we expect from it? If we answer these questions correctly, we will understand the disappointment in recent years. We had thought that it will lift people out of poverty. Consumer microcredit meant for consumption smoothening or household consumption was supposed to be the exception and not the norm. The essence was supposed to be micro entrepreneurial finance. The high growth rates of microfinance firms made one thing apparent: fungibility of money means you don’t know what the poor are really doing with their money. So poor borrowers needed to be doubly careful that they are using the loans in income generating activities that would allow them to get out of poverty and not just to continue living in misery or make it worse.

Finally, finance is only one aspect of life and one aspect of an enterprise. Many other development tools are required including education, health, infrastructure, minimum wages, property rights, public governance, among others. If all the focus is put into one source, there is no balance.

So, to wrap up this discussion, responsible microfinance means getting back to basics and understanding that although 70% of the microfinance institutions (MFI) reporting to the MIX are profitable, and some are earning over 40% on their investment, this profitability may be based on financially sustainable growth rates but not socially acceptable growth rates.

If the MFIs do not behave responsibly, the regulator can start playing its roles in protecting the poor; as was the case in Andhra Pradesh finally. To make an analogy which may be closer at home to your readers, if we had regulated the internet space two decades ago, one would argue that the internet would not have grown and flourished as it has now. The decision not to regulate and not to tax was taken consciously. However, once the internet had grown sufficiently to become ubiquitous (and empowering), many countries are now deciding what is acceptable to their societies in terms of freedom of speech, respect of privacy and respect of societal values.

So is the case with microcredit. Initially, an absence of regulation permitted it to grow organically and flourish. Now based on this platform, microfinance institutions (MFI) would like to cross-sell not only other microfinance products but also consumer goods like telephone, water, or environmentally friendly stoves. Regulators are now coming in to decide what is acceptable. Responsible Microfinance needs to set up apex networks to explain to the government what it needs to survive as well as make a buck in addition to the bang. But in the end, it also has to let the bang occur and not just keep the buck.

Socially Responsible Investors in the developed world would find it difficult to keep track of individual MFIs in individual countries. One strategy would be to follow only the high financial return MFIs which are of a certain size and screen out those who behave irresponsibly. We know that 80% of the lending takes place in South Asia, in terms of number of borrowers. But Latin America has much larger loan sizes. So, if the objective is to be a socially responsible investor, highly profitable firms need to be tracked. If the objective is to be a social investor, perhaps smaller firms providing loans in Africa need to be tracked in addition to those in South Asia. Media reports are, unfortunately, few and far between for Africa.