ETHICAL ISSUES IN MICRO FINANCE

HARSHAVARDHAN REDDY NIKESH GADEWAR PRADEEP REDDY

INTRODUCTION
Microfinance is a unique credit model that allows capitalism in a social

context by creating an optimal mix of profit motivation and social entrepreneurship.

This merging of two traditionally divergent philosophies makes

microfinance a delicate balancing act, which increases its vulnerability to criticism on ethical grounds.
Here are 6 ethical questions in microfinance, along with their censures

and relevant explanations that help clarify the intentions of practitioners.

CREDIT POLLUTION
This occurs when multiple microloans are advanced to individual clients without

much consideration of their credit ratings or repayment capacities because microfinance institutions (MFIs) simply wish to widen their customer base.
This behavior is typically driven by intensifying competition in the sector because a

failure to expand or maintain clients will spell failure for the firm.
As a result, clients become over-indebted and many defaulters may simply visit the

next MFI for a new loan, carrying their debt with them.
In the long run, the market may face a repayment crisis, as in Bolivia.

PROFIT MOTIVATION
Many critics say it is not fair to profit from the poor but they fail to

realize that interest rates need to be charged to ensure financial sustainability on account of the less-than-perfect repayment rate (usually 95-98%)
Overheads and high transaction cost of manually extending a large

number of small loans to individuals in remote areas.

Nevertheless, it is difficult to know the difference between greed and

sustainability.

HIGH INTEREST RATES

Many MFIs to charge excessive interest on loans but proponents of the

free market economy believe higher rates will attract competition and improve the flow of funds to the poor.
And in the long run, competition will help lower interest rates.
However, this income often leads to fat bonuses and paychecks for

managers of MFIs, and cases like those of bank compartamos highlight

the severe danger of mismatched financial and social objectives.

MERGING BUSINESS AND CHARITY

At the other end of the spectrum lie MFIs that aim to succeed purely as a

social business.
They employ poor credit control and as Professor Yunus puts it, credit

without discipline is charity.

These firms may forget that being too compassionate will prevent financial

sustainability owing to an increasing number of loan delinquencies.

MFIs must partner with their client and ensure mutual success, and when

borrowers default, their loans should be rescheduled instead of forgiven, or

their credit histories may be reset if they seek new loans.

TRANSPARENCY IN PRICING
The lack of transparency in pricing is a direct result of high interest rates

on micro loans because MFIs wish to target as many borrowers are possible, yet profit maximization remains an objective.
Hidden transaction fees, interest rates, sales taxes and compulsory

deposits (which act as collateral) mean the rate charged is a lot higher than the rate advertised.

GROUP LENDING
In an effort to lower the risk associated with collateral-free micro

lending, many MFIs practice group lending, which acts as a form of social collateral.
This delivers immense advantages in terms of lower costs and

cooperation, as a result of which MFIs boast high repayment rates, especially among women.
This became a moral issue when it was revealed that group borrowing

leads to immense peer-pressures that women cannot bear (Source: WSJ WSJ: Group Borrowing Leads to Pressure).

Cont..
In other words, the high repayment rates may be a result of the inability

of women to bear opposition and disapproval of their group members, and not because they are inherently good entrepreneurs.
Microfinance, like any other social enterprise, has to tackle many gray

areas and this context helps us appreciate the dilemma faced by MFIs on a regular basis, and appreciate the effort put into managing the delicate balance between social good and financial independence.

MFIs are charging exorbitant rates of interest. Not only that MFIs charge absolutely high interest rate (upwards of 20 per cent), but their practices like forced savings, applying a flat rate method and adding service and other charges, over and above the annual interest rate, further exacerbate the cost. This is leading to an overall high cost of borrowing for the poor, making MFIs rates look almost usurious. Further, MFIs lack transparency with regard to their interest rate practices, which is helping them to transfer various costs on to gullible borrowers; 2) MFIs are resorting to unethical ways of recovering loans by confiscating title deeds, using intimidation and abusive language, and combining multiple products like savings, insurance and loan to ensure prompt recovery; 3) MFIs are aggressively poaching from government and banks to capture their borrowers. They are luring the members of government supported SHGs by liberally financing them, leading to multiple financing. Because of such practices, it is argued that MFIs are causing a huge burden on the poor, leading to a vicious cycle of debt, poverty and even deaths .

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