Efforts to discern ethical behaviour can lead to quite different results. Gandhi uses the most wretched person as the guide, Gauss stresses central tendencies, and Hayek suggests that specialisation is essential for a productive society. Use of finance has always been a lightening rod for ethical debate.
Microfinance (MF) serves the entrepreneurial working poor, getting people into business for themselves and moving the frontier of formal finance somewhat closer to Gandhi’s benchmark. MF that succeeds on a commercial basis generates other positive social effects through financial markets. For many microentrepreneurs, MF may enable them to participate in their first formal contract. Formality advances the power of contracts rather than of class, tribe or status to strike mutually remunerative commercial transactions. Power diffusion is more likely. Women are especially suited to these new opportunities: Grameen Bank in Bangladesh issues loans to women who have never before held a coin or banknote in their hand. However, savings, not credit, is historically the engine of enterprise. Few microentrepreneurs become small business people or build medium-size firms. Competition and capacity tend to keep micro micro.
Micro and small business interest rates may appear “high”, but they are often the lowest available. In a sense, interest rates are a mathematical abstraction – the microentrepreneur’s concern is the size of the payment due and whether the loan was helpful. Transparency, with uniform rules of calculation, constitutes best practice.
Tangible collateral is not very important in MF when information and incentives are properly aligned. Loans to small and medium businesses are usually collateralised because these entrepreneurs have more options and hence more complex cash flows.
Micro, small and medium-size businesses in many countries face dreadfully inefficient financial markets. World Bank economists have found that financial market development is pro-poor because it creates jobs and economic activity generally.
MF is subsidised, creating ethical ambiguities. These appear in ownership patterns and in economic rents, and will continue as long as subsidies flow to microfinance institutions.
Mission drift is said to occur when service to an original target group is expanded to embrace other target groups. This is usually justified by a desire to grow with clients, by providing access to formal financial services, and by creating employment. Consumer finance is often non-transparent, costly and unproductive. It is the biggest threat to MF.
Pensions lose value when currencies collapse. If history is a guide, collapses are likely to occur in many countries over a working lifetime. How could the savings of nascent middle classes and of the working poor be protected when hyperinflation occurs?
Finally, Compartmos, a highly successful Mexican microfinance institution, made a secondary offering on the New York and Mexican stock exchanges in 2007. Its individual and institutional shareholders reaped extraordinarily returns. At the same time, Compartmos has achieved very high rates of expansion, serving more and more poor Mexicans. The scale of its returns has created a large stage for ethical debate.