Is Microfinance still trendy?
A guest commentary from Jürgen Hammer, Managing Director of SPTF.
Jürgen Hammer Managing Director SPTF
Jürgen Hammer holds the position of Managing Director at SPTF Europe, the Social Performance Task Force, where he oversees the European office located in Luxembourg. In addition, he steers the Social Investor Working Group of the SPTF, working closely with the investor co-chairs.
In light of recent developments and discussions surrounding the impact market, we sought his expertise to shed light on the future of microfinance and whether it will continue to be a mainstay in the financial landscape.
Is microfinance still trendy?
In my interactions with the impact investment community about the microfinance sector there is a certain type of comment that I often hear and that bothers me: Microfinance is no longer the darling of development finance. But was microfinance ever only a trend? Should the "fashionability" of a sector really guide investment decisions?
From a financial and business perspective, the only question we need to ask is: is there still a demand, or has microfinance achieved its goal of bringing everyone into the financial system and providing universal access to safe, affordable and convenient financial services?
The answer is a resounding NO! There are still 1.4 billion adults worldwide who remain unbanked according to the Global Findex Survey by the World Bank, in 2021. These adults are more commonly women, poorer, less educated and living in rural areas. That is pretty compelling evidence of ongoing demand.
However, market demand alone will not be sufficient to justify investing in the microfinance industry and ensuring its high impact relevance. After all, there is strong market demand for all sorts of goods and services, from alcohol and tobacco to junk food, that most would argue do not belong in an impact investment portfolio.
But from a development and impact perspective, the issues are much more complicated. Over the past 25 years, the microfinance industry has gone through a cycle of thesis, antithesis, and synthesis. Early communication, mostly based on anecdotal evidence, may have oversold the impact of microfinance, promising that it would “put poverty in a museum”. This optimistic narrative was then followed by randomized control trial (RCT) studies that counterbalanced much of the earlier positive reports.
Now, there is a thoughtful debate about whether we have been asking the right questions in the first place. A June 2023 article by the Global Development Network, a spin-off of the World Bank, is a good recent example. It describes poverty not just as a lack of money, but rather as an interplay of insufficiency (such as a lack of money), instability (such as unpredictability about when money will arrive), and illiquidity (such as a shortfall of money on hand to meet immediate, often unexpected needs).
Based on such an approach, to fulfill its mission and reach its full development potential, the microfinance sector must address and overcome two major challenges:
1. Differentiating Impact from ESG
With the implementation of the Sustainable Finance Disclosure Regulation (SFDR), we need to pro-actively answer the question on how impact investing and microfinance stand out from ESG investing. As we all know, ESG investing focuses on compliance with minimally acceptable standards in order to mitigate negative risks rather than on creating positive impact – but this is a message we need to send much more carefully and forcefully.
In addition, the 'E' in ESG is overshadowing the 'S' and 'G' as the effects of climate change become increasingly apparent also in the “Global North”. We must therefore leverage the historic experience and strengths of the microfinance sector in assessing social performance and governance to ensure these factors receive as much attention as environmental concerns.
2. Proving our Impact
To prove our impact we must effectively measure, report, and communicate, which requires transparent evaluation and reporting. A lack of standard methodologies prevents a comprehensive view of our performance.
Under the umbrella of SPTF, its global network, the worldwide microfinance industry has been working together since 2005 to create this common language and jointly defined standards. They are a prerequisite, similar to what we have with financial accounting using IFRS and GAAP, to transparently measure our performances regarding social and environmental bottom-line objectives.
Yet, without regulatory authority mandating transparent social and environmental reporting, any commitment to transparency remained voluntary until recently. For Europe, SFDR is a step in the right direction, but it requires excessive and sometimes irrelevant reporting from microfinance investments.
Hence my two Calls for Action: (1) in the microfinance and impact sectors, we must align our actions with our words and implement transparency, i.e. proactively contribute to the development and then the implementation of common standards. And (2) we need a better approach to data sharing. Our sector possesses huge amounts of data already, and the real challenge is how this data is better shared and made comparable.
A disruptive approach to impact investing is especially significant given the current context of Environmental, Social, and Governance (ESG) factors and Positive Impact Assessments (PAIs) gaining widespread acceptance in the global financial sector and economies.
The thorny issue of relevance and of proportionality
Finally, I would like to make a fundamental observation, which is rarely given the importance it deserves, regarding relevance and proportionality. Portfolio reporting requirements, for example set by the currently proposed harmonized EU taxonomies for the financial sector, were not designed with the microfinance sector - and more broadly the “Global South” - in mind. As a result, microfinance funds and their impact investors find themselves measuring and reporting on indicators such as the greenhouse gas emissions produced by a smallholder farmer in Africa, the water consumption of a small shopkeeper in Latin America, and the breakdown of non-renewable energy consumption by type for a small trader in a Middle Eastern souk. For the same type of end-borrowers, microfinance funds are asked about their compliance with the UN Global Compact principles and the OECD Guidelines for Multinational Enterprises. This is out of proportion, and simply not relevant.
The microfinance sector has worked hard over the past two years to comply with the European Sustainable Finance Disclosure Regulation. But we must ask ourselves: with Africa contributing for about 4% of global carbon emissions, are these really the relevant negative impacts of investing at the bottom of the pyramid in the “Global South”? Our experience on the ground tells us that what really matters, both locally and globally, are issues such as deforestation for agricultural expansion, soil degradation and erosion, water scarcity and inefficient irrigation, pesticides and chemical pollution.
Although these regulations are formulated with good intentions, the current situation is not sustainable, neither from a moral nor an economic point of view. The level of information required, the limited value it adds to the global picture, and the effort required to obtain it create a significant discrepancy between the North and the South. As asset owners and investors, let's remember the importance of relevance and proportionality when setting our internal expectations.
To conclude
The world's financial systems and the development sector need a strong microfinance presence. Even if the earlier rhetoric about microfinance was exaggerated or irresponsible, certain undeniable facts remain. Everyone needs access to safe, affordable, convenient and effective financial services, and not everyone currently has that access. Microfinance remains a critical strategy for bridging this gap, especially for hard-to-serve populations in developing countries.
Far from being an exhausted trend, microfinance is a sector poised for growth. A rejuvenated commitment to its social mission and to professionalism can and will drive an expansion that matches the existing, as-yet unmet demand.