Investing in the Poor The Ethics of Microfinance

Running Head: INVESTING IN THE POOR: THE ETHICS OF MICROFINANCE
Investing in the Poor: The Ethics of Microfinance
Luke Rzepiennik
Azusa Pacific University
November 11, 2014

INVESTING IN THE POOR: THE ETHICS OF MICROFINANCE 2
Abstract
Microfinance has been hailed as the twenty-first century cure to poverty. The idea of
empowering people to lift themselves out of poverty rather than simply being the recipient of
charity is attractive to all those fighting the war on poverty. The idea is that it will create
sustainability and long lasting economic and social growth. This paper will seek to bring to light
the ethical issues that the microfinance industry faces today. These issues include the
effectiveness of microfinance, the neglect of the poorest clients, and drift of the central mission
of microfinance; highlighting results of research in many different areas. It will answer the
question, “is microfinance really as ethically-forward a form of investment as it has been
advertised?” It is concluded that it is possible for microfinance be done in a way that is both
effective and ethical. Recommendations for reaching these goals are given. They include
increased transparency, greater cooperation with other organizations, knowing clients better, and
working to drive interest rates down. Through these courses of action it is possible for
microfinance to play an effective role in ending poverty.

Section 1: Introduction
In 2005 the United Nations declared it the “Year of Microcredit.” The next year, the
Nobel Peace Prize was awarded to Muhammad Yunus and the Grameen Bank, a leading
microfinance institution (MFI), for their work in microloans. In the last decade microfinance has
been hailed as the cure for poverty; it has been claimed that by providing small loans to the poor
who would otherwise have no access to such financial services, they will be able to lift
themselves out of poverty. This idea is one that makes sense when presented in this manner.
People love the idea that they can both invest their money and help people at the same time.
With this growing trend, research is now finally being done to ask the question, “does it work?”
In addition, MFIs are now being put under a microscope. Many institutions have been accused
ethical violations such as charging unreasonably high interest rates, using exploitative lending
practices, and using forceful methods to recover funds. These issues become even more
prevalent as many MFIs are choosing to transform from a not-for-profit model to for-profit one.
The drive for profit can cloud what is supposed to be the true mission of MFIs, serving the
poorest of the poor. The Prime Minister of Bangladesh claimed that MFIs “are sucking blood
from the poor in the name of poverty alleviation” (Ahmed, 2010: 1). This paper will seek
investigate the effectiveness of microfinance, define the key ethical issues faced by the industry,
and reach a conclusion on whether or not investing in microfinance is truly as ethically-forward
as it has been made out to be.

Section 2: Does it work?
The first step in deciding what to believe about microfinance is to discuss if it actually
works. MFIs are generally seen as a hybrid organization with dual purposes, to do good and to
do well. This means that they are providing financial services and products to those who would
not normally have access to them, but they must also perform well as financial institutions
(Hudon, 2013). MFIs, whether non-profit or for-profit, have real investors that want to see a
return on their investments, whether social or financial. It must be determined if these goals are
actually being met. To do so, the results of microfinance must be examined. Microfinance is a
relatively new trend and therefore has less conclusive data and research available than other
forms of investment; however, there is enough to begin to make some general conclusions. This
section will lay the groundwork to do just that.
2.1: Economic Impact
The first area to be examined is the economic effects of microfinance. To begin, a
macroeconomic perspective will be introduced. Studies show that the emergence of capital
markets has a direct link to economic growth within a country, as judged by gross domestic
product growth per capita (Banco Interamericano de Desarrollo, 2005). Other studies, however,
show that the impact of capital markets is significantly less in developing nations (Levine &
Zervos, 1998). This is because most developing nations lack a comprehensive banking system;
capital markets rely on a fully developed banking system to function efficiently (Prior, 2009). A
lack of access to loans and savings cripple the public from participating in these markets.
Microfinance gives those that have been excluded by the traditional banking system access to
financial services. By giving a broader portion of the population access to savings, loans and

other products, they gain the capacity to participate in capital markets. This creates opportunity
for growth of the capital markets and, in turn, macroeconomic growth can be observed.
A microeconomic viewpoint will now be taken into account. A measure that is often used
in research of this type is ‘average expenditures per household.’ Researchers can track how much
a household is spending before and after microfinance is implemented. The results of these
studies vary greatly. The first and perhaps most obvious variation was seen in those who were
more highly educated or had previous business experience. These people were able to make
better use of the funds that were borrowed. In addition, women on average showed better
economic growth when compared to men. In a study done by A. Banerjee from MIT, it was
found that the number of small businesses in “treated” areas increased by one-third; however, the
average monthly expenditure of the area did not increase. It has recently been argued that
although microfinance often does not affect the average monthly expenditure it does increase the
community’s economic resilience (Banerjee, 2010). An extra source of income makes a
community less vulnerable if there is a fallout in another area of their economy (i.e. there is a bad
fishing season).
2.2: Empowerment Impact
Another measure of success for microfinance is how well MFIs are empowering the
people beyond an economic standpoint. Tavanti argues that for microfinance to work a broader
approach must be taken. MFIs need to invest in the human capacity and the social capital of a
community if it is to thrive and provide a return (Tavanti, 2013). A major issue with many
poverty relief efforts is that although they are attempting to do good and perhaps help in the short
term, they create a dependence on aid. When the effort ends or loses funding, the community it

was serving is left in a far worse spot than they were before the ‘help’ came. Therefore, it should
be the goal of all poverty relief efforts to create sustainability within a community. Rather than
carrying people out of poverty, people should be given a hand up so that they can continue to
grow on their own. This should be a central goal for all MFIs.
Many MFIs have the goal of helping to foster economic equality within communities. By
lending to the poor and the oppressed of the society, like women, it can help lift the entire
community up. However, Mayoux found that lenders became a target for manipulation by the
more influential members of the community. In many cases, the funds borrowed fell under
control of these powerful individuals or groups. Instead of helping to alleviate the income
inequality, the microcredit makes it worse (Mayoux, 2001).
An interesting trend in microfinance is the bias toward lending to women. Over seventy-
five percent of all microborrowers worldwide are women. It is thought that by empowering
women, who are at the bottom of society in many areas, it will help to foster economic equality.
In addition, it is thought that in poor households, men are generally the main source of income.
By giving women the opportunity to also generate income it could increase the overall income
for households. While these are all great ideas, research has shown some flaws in this plan. It
was found that although women are provided with the capital to start bringing in income,
because of their status as women, they are still held to lower income jobs with little room for
growth. It was also found that the funds that women received from microloans often times turned
into household assets which were in turn controlled by men. Discrimination was also found
within the MFIs regarding giving women loans. It was found that the women who wanted to take
on bigger projects were almost always downsized or rejected all together (Hudon, 2013). It
seems that although most of the microloans being issued are going to women, little progress is

actually being made in the area of empowering women. One suggestion for a solution is for
MFIs to offer more accessible savings products. Ashraf is one of the few who have conducted a
study on the effects of microsavings. The study found that women who were given access to
private savings accounts gained decision-making power within their households (Ashraf, 2010).
It seems to come back to Tavaniti’s argument that more is required for success in microfinance
than just providing the funds.
2.3 Livelihood Endowment Status
As previously stated, the problem with many poverty relief efforts around the world is a
lack of self-sustainability within the community that is receiving aid. As soon as the funding
dries up and the volunteers leave, the community falls back into disarray. A main reason for
these types of failures is a lack of understanding of what the community actually needs.
Governments and organizations too often throw money at the problem, not actually doing any
good. In a similar way, if MFIs are not careful, particularly the for-profit institutions, they will
fall into the same trap. What is required is a fundamental shift in how the poor are perceived. The
basis of microfinance as a form of poverty relief is that the poor are actually functioning people
with the ability to, with a hand up, pull themselves out of poverty. This is a brilliant first step to
changing how the poor are seen. The issue that many organizations today are running into is that
they still see poverty as a one dimensional, economic problem. This is not the case. Francis
Njoroge teaches his students of Community Development that poverty is a mindset. People may
be lifted out of economic poverty but unless they are poured into as people, they will never stay
that way; let alone help their community rise above it. Poverty must be seen for what it is,
complex and multidimensional. The solution, therefore, must be equally so.

de Haan developed a model for determining the overall impact that the introduction of
microfinance has had, not just on the economic growth experienced by individuals, but also on
how the beneficiaries have used their assets, focusing on what each culture and community
deems to be required for a “good life.” This model is called the Livelihood Endowment Status
(LES). Rather than beginning with a wealth assessment, as most measures of livelihood do, it
starts with the assets that people value most within the community. Through community
meetings and observations these assets are determined. This creates a base from which to start
measuring as the community strives for not only economic success, but also social, political and
physical advancements. Using this model, a study was conducted that compared the well-being
of microfinance clients to that of non-clients over three years in Uganda. The study found that
although there were gains in the financial asset portfolios of the clients, they saw a loss in social
and physical assets. de Haan concludes that based on these findings clients were no better off
than non-clients after the three years of study (de Haan, 2010).
At the same time another study was done within the same communities but focusing on
the empowerment and social emancipation experienced by women. This study had quite different
findings. It was found that through microfinance, women became more independent, with a sense
of pride in the contribution they were now making to the income of their families. In some cases,
women were even creating jobs that were filled by their husbands. It was seen that women were
beginning to push the boundaries of what in meant to be a women in these rural societies. Some
women even now have their own bank accounts. Women also began to trade in core market
areas, an area previously reserved for men. Perhaps the best indicator of social emancipation in
these areas was the observed increase in property ownership rights. In many areas, particularly in
African communities like those in Uganda, women traditionally have not been? allowed to have

ownership of property. The study saw an increase in women having ownership of land, money
and animals (de Haan, 2010). This diversification of activities and an increase in pride shows
that microfinance indeed can have a great hand in the social emancipation of the oppressed.
Section 3: Responsibilities and Ethical Issues
The senior manager of the microfinance department at Triodos Bank, one of the only
European banks to allow individuals to invest in microfinance, tells us regarding whether or not
to trust a particular MFI, “It all comes back to values. You have to ask what is their main motive
for getting into this business (Dossa, 2014)?” Since 2006 was declared the “year of Microcredit”
more and more MFI have been popping up all over the world. Many see the good that can come
from microfinance work and are striving for an end to poverty; however, there are also those in
the business for reasons centered on exploiting the poor to make money. These institutions may
even see themselves as righteous, making money while helping some people out in less fortunate
situations. As demonstrated in the previous section, however, this is an industry that cannot be
participated in effectively and ethically if the goal of the institution does not remain focused on
helping the poorest of the poor. This section will seek to determine the ethical responsibilities of
an MFI and the current ethical issues that are faced by the industry.
3.1 How Should MFIs View Ethics?
Business ethics is a topic that is constantly being debated because of the many ways a
given situation can be viewed. While some situations may be a clear violation of ethical
behavior, many decisions contain much grey area. Looking at a given situation through various
ethical lenses can be useful in gaining perspective on these matters. A business has the obligation
of having a code of ethics and following it. It can be argued that because of the direct impact the

MFIs have on people, particularly the poor who have no real way to battle unethical practices,
MFIs have an even greater obligation to hold to this code. A code of ethics will help to eliminate
a deviation from the firm’s original mission; in the case of an MFI, to alleviate poverty. The
decision must, then, be made as to which code of ethics an MFI will follow as it makes policy
decisions. This section will discuss how the work of MFIs can be viewed from a virtue,
utilitarian and deontological viewpoint. In addition, it will argue that virtue-based ethics is the
best from of ethics for an MFI to follow.
A utilitarian view of ethics judges the ethicality of an action based upon what will
produce the best result for the greatest number of people. In other words, it is outcome based and
things like reflecting good moral character and high standards become less important
(Chakrabarty, 2013). An MFI that adopted this form of ethics would likely be focused on the
overall impact and financial success of the MFI. While this is an important aspect of an MFI’s
work, this way of thinking can also be dangerous. An MFI that is focused primarily on tangible
results will likely begin to take on more clients that have higher chances of substantial success
and those who really need the help, those at the bottom of the pyramid, will be forgotten. This
form of ethics could also lead to an over-emphasis of the end result of a project; a train of
thought that leads to ‘the end justifying the means’ can also be dangerous. Compromises of
personal or company ethics for the sake of a project are not acceptable. Once corruption begins,
it spreads to infect the entire institution.
A deontological-based code of ethics for an MFI also has its strengths and weaknesses.
Deontological ethics judges the ethics of policies based on rules, laws and regulations. For an
MFI, this would invoke policies directed towards the responsibilities that the institution has to its
stakeholders: employees, donors, investors, and clients (Chakrabarty, 2013). This is an important

viewpoint because without a broad view of the institution an MFI can fail all together and thus
cease to accomplish its mission of alleviating poverty. The issue with a deontological view is
similar to that of the utilitarian view; it is too detached from the core mission of an MFI. As
financial conditions become tighter and more pressure comes from donors and investors, the
well-being of clients can easily be pushed to the way-side.
A virtue-based ethics for an organization focuses on reflecting the moral character of the
institution. The core mission of an MFI is to reach the poorest of the poor and give them a hand
up out of poverty. It is far too easy for an institution to see a drift in its mission as time goes on.
If its code of ethics, however, reflects that core mission of the MFI and the code is not deviated
from, it will help to keep the organization on track. If an MFI is able to keep its main focus on
the client, it can do the most good. The purpose of most businesses is to make a profit; however,
the goal of MFIs is to create change. If it is making money but not truly helping the poorest of
the poor, it is not fulfilling its mission. By creating a code of ethics that is based on the moral
character of an MFI, it can better serve its clients.
3.2 MissionDrift
Another facet of the microfinance industry that needs to be addressed is the growing
number of for-profit MFIs and how they are looking increasingly different from the not-for-
profit (NFP) microfinance institutions. Each type of organization has its own strategic orientation
as well as its own strengths and weaknesses. Supporters of for-profit MFIs note that NFP
institutions face restrictions from donor organizations like project approval, evaluation and
reporting. In addition, NFP institutions are more likely to run into ideological, social or political
issues that work at odds to the institution’s goals. Critics claim that these restrictions reduce the

efficiency of the institutions and therefore limit its ability to successfully manage their loan
portfolios. Other issues such as donor fatigue and lack of diligent management are also potential
hindrances. All these factors make it more difficult for MFIs to become self-sustaining and
ultimately be less effective at alleviating poverty. It is argued that for-profit institutions are in a
better position to create economic gains, being that they are profit oriented. The main issue with
for-profit MFIs, however, is that although they are creating economic gain, the social,
educational and environmental issues that are often the root cause of poverty are more likely to
be ignored (Casselman, 2013).
The neglect of the poor by for-profit MFIs is the phenomenon known as mission drift.
The early pioneers of microfinance set out with the central goal of serving the poorest of the poor
and this remains the mission of many MFIs today. When organizations switch over to a for-profit
model, the focus of the firm also changes. Commercial success becomes the main goal and
serving the poor often falls to the wayside, becoming simply the means for financial gain (Cull,
2007). An example of proof that mission drift is occurring is the reduced lending to women. A
study done by Women’s World Banking that examined MFIs in 29 countries as they shifted from
NFP institutions to for-profit institutions showed that over 5 years the average number of women
lenders went from 88 percent down to 60 percent (Frank, 2008). There is less focus on those who
really need the financial support and more focus on who is going to have the best return rate:
men who have had business experience or higher education. These, of course, are the groups that
need less help.
Considering these things, the question of whether or not NFP institutions are financially
strong enough to make a lasting impact still remains. Most MFIs have a goal of having
community development programs accompany the loans so that there is greater stabilization in

the area and more than just a financial impact is made. The amount of resources required for this,
however, make it difficult for many NFP institutions to apply this. The financial power of for-
profit MFIs could lead to much greater potential for development in this area (Casselman, 2013).
This is the reason that many NFP MFIs decide to shift to a for-profit model. Managers see all
they could do to help the poor if they had the funding and organization of a for-profit institution.
Their intentions are pure and so then the question of how to avoid mission drift becomes a main
focus.
Frank suggests that an open dialogue with potential investors is essential to finding the
right measurements for mission drift in a transforming company. Microfinance works in a
diverse set of areas and so the process cannot be standardized. It follows that the measurements
of success also cannot be standardized. By individualizing the process and the measurement of
success, MFIs can be much more effective. With this in mind, Frank suggests a number of
questions that need to be asked. First, in must be determined who the target clients of the newly
transformed MFIs are. This should be reflected in the mission statement of the MFIs and provide
for how accommodations will be made to ensure continued support of the poorest of the poor.
Secondly, It must be decided what indicators will be used to measure social progress and how
they will be curtailed to the specific areas of investment. Becoming a for-profit institution will
require a greater amount of organization and transparency and so these indicators will have to be
closely monitored and reported to board members and investors. As the MFIs transforms it will
be even more important to keep track of these indicators as the changes in service may affect the
client. Finally, it must be determined how money will be managed. The main goal of
transforming into a for-profit MFI is to have access to cheaper funds; it must be laid out how
these savings will be passed on to clients. A structure should also be set up of how changes in

profitability will change interest rates (Frank, 2008). As previously discussed, many MFIs are
accused of charging outrageously high interest rates; making a plan beforehand and sticking to it
will help to keep this from happening.
Shifting from a NFP to a for-profit model can be highly beneficial for an MFI. Intentions
are often very good but can be lost in the struggle to make a profit. The issues and questions
above are just a few of the ways that can help to keep MFIs on track as they transform. It is clear
that both types of MFIs have value and can be beneficial to their clients. The key to success may
be the forging of partnerships between these organizations to foster both financial and social
gains. As one grows so too will the other, achieving the ultimate goal of poverty alleviation
(Casselman, 2013).
Section 4: Biblical Perspective
A consistent theme in the bible is the heart that God has for the poor and the care that His
people are commanded to have for them. Deuteronomy 10:18 states that, “He defends the cause
of the fatherless and the widow, and loves the alien, giving him food and clothing.” Psalm 9
declares that the lord is a refuge and the poor will not always be forgotten. Christians, in aligning
their hearts and will with God’s, should have the same passion for defense and liberation of the
poor. This passion calls forth action on behalf of the oppressed. There is no question that
scripture supports the fight against poverty. The proper means of fighting, however, are
somewhat more difficult to discern. This section will use scripture to examine the fundamental
practices of microfinance in comparison to the commands that the bible lays forth.
When addressing the Israelites in Deuteronomy, God makes provision for lending.
Deuteronomy 15:7-8 commands that, “If anyone is poor among your fellow Israelites in any of

the towns of the land the Lord your God is giving you, do not be hardhearted or tightfisted
toward them. Rather, be openhanded and freely lend them whatever they need (NIV).” Although
God’s instructions are specifically directed towards fellow Israelites, we know now that we have
all been made one body in Christ and should follow the same instruction of generosity (1
Corinthians 12:13). This passage suggests that microlending to the poor has been going on for far
longer than MFIs have been around. The concept of microfinance is clearly supported by
scripture as a way to help those in poverty. The question comes when we look at other scriptures.
Exodus 22:25 states that, “If you lend money to one of my people among you who is needy, do
not treat it like a business deal; charge no interest (NIV).” Deuteronomy 23:19 makes a similar
command to gain no interest when dealing with fellow Israelites. If the command of generously
lending is applied to everyone, so too should these scriptures forbidding charging interest be
applied. Deuteronomy does allow for the charging of interest to foreigners, but how should it be
decided who is a foreigner? The whole basis of the microfinance industry, particularly in the for-
profit sector, is based on charging interest rates to their clients. In Luke 14:13-14 Jesus says,
“But when you give a banquet, invite the poor, the crippled, the lame, the blind, and you will be
blessed. Although they cannot repay you, you will be repaid at the resurrection of the righteous
(NIV).” This passage encourages not requiring repayment of good deeds; rather, let the good
deeds be for their own sake and repayment will come at the resurrection. These passages seem to
stand contrary to the basic principles of microfinance. How then can these things be reconciled?
As previously demonstrated the practice of providing loans to the poor in nothing new
and is supported by scripture. While other passages seem to contradict the core practices of
microfinance, an answer does exist. Scripture commands that when a loan is given, it should not
be treated as a business deal. The interest a NFP MFI charges is not for the purpose of making

money but for the purpose of sustaining the institution so more good may be done. IF the core
values of the MFI remain intact, their goal will be to drive interest rates down for the benefit of
the clients. The interest rates will only go down as the MFI is able to run more efficiently and
risk is better dealt with. It is much more difficult to reconcile a for-profit institution with
scripture. A focus on profit rather than on people is in conflict with what is taught. This brings
full circle the previously made points regarding the value of virtue ethics and the dangers of
mission drift that for profit MFIs face. It further calls into question the overall ethicality of for
profit MFI as a whole.
Section 5: Conclusions and Recommendations
This paper has introduced many ideas and identified key issues regarding the ethics of
microfinance. This section will bring together each piece of the argument presented and seek to
answer the initial question, is microfinance truly as ethically-forward a form of investment as it
has been advertised?
5.1 Conclusions
The first question that was asked was, “does microfinance work?” This was a necessary
first step to determine whether or not microfinance was effective at alleviating poverty. In the
areas where microfinance is being applied, the number of small businesses increased an average
of one third; it also created greater resistance for the community to economic fluctuations. The
providing of financial services to broader populations within developing countries allows more
people to access capital markets. The growth of the capital markets within a country will help
foster economic development. It was also asked what kind of social impact was being made by
microfinance. While results of studies vary greatly and are largely inconclusive, many good

results have been found. While many issues exist within the institutions and their policies,
positive social change has been observed, including empowerment of women, increased
entrepreneurship, and greater economic equality. It can be concluded that microfinance can work
when done correctly. If done incorrectly or without the correct intentions, the results can often be
damaging; perpetuating dependence and oppression. The circumstances that allow for
microfinance to work are still a matter of debate.
The ethical code that is followed by an MFI is critically important to its success. The
microfinance industry is currently under a microscope for unethical practices and so an MFI
must be ethically sound if it hopes to continue attracting both clients and investors. It was argued
that a virtue-based ethical approach to policy making for MFIs is the best for avoiding mission
drift. It was suggested that increased transparency of MFIs with investors and the industry could
also help keep an institution accountable. There is hope that the ethical issues within the industry
can be overcome and microfinance can become even more effective at alleviating poverty.
Finally, a biblical perspective was examined. It was found that lending generously to the
poor when they need it was a command given by God long before any formal MFI was created.
It was also discovered that fairness and generosity are required in all of these dealings. The loans
should not be treated as a business deal but as an act of good will. As a result, it can be argued
that for-profit MFI not only run a higher risk of experiencing missions drift, but also clash with
commands given by God regarding loans to the poor.
5.2 Recommendations
In 2008, leaders in the microfinance industry came together to address the ethical issues
within the industry. Although each leader came with their own viewpoints and ways of doing

things, they were able to come together to create and sign an official code of ethics for the
microfinance industry (Papini, 2008). This document, called the Pocantico Declaration urged a
few key points going forward for MFIs: (1) Increased interaction between MFIs and other types
of poverty relief organizations (2) Knowing clients better and as a result offering a greater
variety of financial services (3) Greater transparency with donors and investors (4) Better
monitoring of over indebtedness of clients (5) Higher standards of social change, particularly for
those institutions receiving public funds (6) Working towards greater efficiency to drive interest
rates down.
Based on the findings of this paper and the progress made by the Pocantico Declaration,
in can be concluded that there is hope that the microfinance industry can run both efficiently and
ethically. Each of the points made in the declaration is essential to its success. Although there
have been no studies on the effects of the Pocantico Declaration, the fact that these issues are
being thought about and discussed gives hope that the microfinance industry will continue to
grow and make a greater impact.
So is microfinance truly the ethically-forward form of investment that is has been
advertised as? The answer is both yes and no. Microfinance has many ethical issues to work
through. The corruption and lack of diligence are issues that will likely always be present to
some degree; however, if MFIs can come together as an industry and fight against these issues,
progress can be made. It is also up to donors and investors to demand increased transparency and
do thorough research on an MFI before investing. Microfinance may not be the ultimate cure to
poverty; however, it has been shown to be an effective partner in the war on poverty. The
underlying goals and core principles of microfinance are good and ethical and ultimately, worth
fighting for.

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