Microfinance Focus, August 1, 2011: Sam Mendelson is the co-author of the Microfinance Banana Skins Survey since 2009. He is the founding partner of SPA - a social performance management consultancy - and former programme director of the Centre for the Study of Financial Innovation - a London-based think-tank.

In an interview with Microfinance Focus, Sam discussed some of the major findings of this year’s survey and delves further into the debate about where Microfinance goes next.

Microfinance Focus: You have been co-authoring Banana Skins since 2009. How do you think the sector’s perception about itself has changed over the years?

Sam Mendelson: Going back to 2008, if there was any risk, it was about how you manage the runaway success of the sector, so it was very self-congratulatory. The sector’s presumption was about how we have cracked it and found the silver bullet to end poverty.

In 2009, there was the global economic crisis and the concern was how much that would impact the microfinance sector and whether the existed presumption that microfinance was shielded and immune from the troubles in global capital markets is correct or not.

In 2010 of course the concern about the broader crisis had eased somewhat but now it switched to a within sector crisis, specifically centred in AP India, Nicaragua, Pakistan, Bosnia and Morocco. There has been a drastic shift in self perception.

Some issues were around for a while like is microcredit more important than savings, should we be shifting towards commercial side and getting sustainable funds or is it still a social sphere. A lot of debate right at the moment if about what microfinance is for. Is it for poverty alleviation, which was the dominant belief for the last 40 years or is it for financial inclusion?

Some of the perception changes are really existential like what are we doing it for? Is it about creating another emerging market for western investors to make money or is it about having a bottoms-up, democratizing, empowering, women focussed way of pushing aside old models of charity and aid and allowing people to use that empowerment.

The presumption that microfinance is always good and if you give poor people credit you necessarily help them is gone. It is being replaced by a lot more nuanced understanding that microfinance can be an incredible tool for change if you combine fair and ethical access to credit with other products like insurances and remittances and savings along with an oversight and good monitoring of social impact, discretion and flexibility in case of shocks.

Microfinance Focus: Many recent reports including Banana Skins draw attention towards the weaknesses in the existing microfinance models or its methodological flaws. Which rules do you think MFIs need to rewrite?

Sam Mendelson: Some of things that consistently popped up in Banana Skins and other surveys are the shortage and ineffectiveness of credit bureaus that is required for reducing multiple borrowing. This was one of the major factors in AP crisis.

Some of it is about incentives as well. The credit officer has a family to feed as well. His motivation is not to help the poor people, it is to take the best salary he can, So incentives need to be thought about. Whether you are giving incentive for new client numbers rather than for portfolio risks, repayments or for retaining clients is important.

For many years there has been the problem of currency risk which is now getting better. Microfinance model takes dollar, euros and pounds from the investors and then lends in a local currency which means people have to absorb it.

I think some of it is about recognizing that it is an art as much as it a science. It is about dealing with new business clients, assessing their potential. To be able to see whether the client has the motivation and spark to really scale her micro business into an SME business or is it about subsistence, being able to generate just enough income to survive and that’s fine, there is a room for both.

There is an ethical obligation on every MFI, although many may not agree that if you are going to deal with the vulnerable and particularly women who are much more vulnerable to exploitation, it is incumbent upon the MFIs to have discretion and compassion if default is out of their control.

But I think a lot of these weaknesses are moving in the right direction. When I see the debate in the Smart Campaign or the Seal of Excellence or the Impact Consortium on how to make microfinance more effective and get the client back at the centre of the sector and not the investor then it makes me optimistic about the future.

Microfinance Focus: Do you think MFIs have started taking Social Performance Management seriously or do they still consider it to be an added expense?

Sam Mendelson: I think it is in its early stages. A few years ago it wasn’t done at all and then the raters started offering social ratings and then there has been a growth in bodies like the Smart Campaign and the Social Performance Task Force etc. I think what is growing is the realization that there is a positive feedback loop between financial and social return rather than being opposable where you comprise one to get the other.

The thing which is not very well perceived in Africa of Indian sub continent is the growing interest of the investor in Europe and America. There are huge number of people who are interested in social investment and who don’t believe in charity and they want to be a part of sustainable investments. That is why KIVA has been such a phenomenal success in the US.

Organizations that can demonstrate real social impact and provide a platform to reach out to these potential investors will flourish. Some of them are doing it only for PR or CSR. That is fine too as long as any SPM consultant does it professional integrity. As long as Social Performance Community does these things with rigour and intellectual honesty then everyone would win.

It is usually not very expensive and it is not as much an expense as it is an investment. The money you are putting in social audit gets back at least once over in future investment.

A social audit would often find ways of improving client retention that has financial benefits and will improve the bottom line. So they are far from being opposable, they are complimentary services.

Microfinance Focus: What are your views about the commitment of MFIs towards Microfinance Plus activities? Are things really moving beyond microcredit?

Sam Mendelson: I think it is becoming universally agreed that microfinance is more than microcredit. There is a growing recognition that giving credit without a set culture of savings is really at best neutral and can be counter-productive.

There are some MFIs whose mission is little more than to lend a dollar and collect back a dollar twenty and there are some whose missions are really holistic and I think the later group is growing.

In East Africa for instance there is a large MFI which has built a small city and offering housing loans etc. Although they got the model wrong and doing it the wrong way but a lot of people will learn from it and will see how we can give affordable, environment friendly housing on fair terms to the very poor. The things that will work will be replicated. I think the commitment is growing.

Microfinance Focus: Can you share with us your views on the role MFIs can play in some of the struggling economies of the developed world?

Sam Mendelson: There have been few things which have been tried like Grameen America, ACCION Texas which are working with mostly Mexican immigrants down there. This side of the pond there are CDFIs (Community Development Finance Initiatives).

It is hard enough to define what microfinance means in Sub-Saharan Africa and it is even harder to define it in the developed countries. Is it about financial services to the unbanked or is it a loan of $20, 000 to a small business owner who doesn’t have good enough credit to into mainstream banking?

There could be a vibrant microfinance sector which offers fair rates as they is no reason to charge as much as they do in other parts of the world because it is less expensive to do business over here. The cost of capital is not so high.

In one of my features I wrote that the shortcomings of microfinance in the developed world remain. Few MFIs are sustainable, or at break-even. Efficiency is lacking. The understanding of, and appetite for such a sector, is low. And there are continuing doubts about scalability.

There may be obstacles specific to the developed world. According to economist Jonathan Morduch of New York University, microloans have less appeal in the US because people think it is too difficult to escape poverty through private enterprise – something that is not an issue in Bangladesh. He is critical of what he says rests on a specious win-win proposition: that MFIs that follow the principles of good banking will also be those that alleviate the most poverty.

Microfinance Focus: So where do you think microfinance goes next?

Sam Mendelson: There has been a lot of debate on what microfinance is and what it is not. I think the question should be whether microfinance can work or not and for that question you get a qualified answer ‘yes’ with a ‘but’. It is this ‘but’ that is the important thing and something which people should be focussing on.

Yes it can work but we need a lot many other things for it to work. We need credit bureaus and regulatory authorities who observe but don’t interfere. We need MFIs to be allowed to take deposits, encourage insurance, savings and remittances. We need a culture of education, a poor that is economically active, a formal banking sector that is ready and willing to reach down, proper competition, technological infrastructure and a broad perspective that financial services is a basic human right.

If you get all of these things it is easy to do microfinance. If you get some of them, it is a challenge but it can be done and that is what we should be aiming for.

I think the Indian crisis is the best thing that could have happened to the microfinance sector because it will clear out the loan sharks and the exploiters and what would be left would be the right people trying to figure out how to do it best.