The origins of impact investing - Interview with Rochus Mommartz - Part 1

Looking back to the 1990s, Rochus Mommartz, CEO of responsAbility Investments, shares his personal experience in the early days of impact investing and how microfinance laid the foundations for what was to come. 

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Welcome to the responsAbility Investments podcast. Let's get the legal disclaimer out of the way first. The information provided in this podcast is given for informational purposes only and should be considered neither as investment advice nor as investment recommendation. No liability shall be accepted for the accuracy and completeness of the information. The views presented in this podcast are those of the individual participants and are not necessarily endorsed by responsAbility. Past performance is neither an indicator nor a guarantee for future results. Now find out how microfinance planted the seeds for the entire impact investing industry, which according to the IFC, is a $2.3 trillion industry with nothing but growth on the horizon. In this three-part series, Rochus Mommartz, CEO of Impact investment House responsAbility, sits down for a personal discussion with David Diaz 1 of Responsibilities leaders in Climate Finance, where Rokus reveals what it was like in the beginning, how a niche market was formed, how it expanded, and what the future looks like from his perspective as one of the original players on the journey since the beginning. This is Part 1 of their conversation. So Rokus, you've been CEO at responsAbility for quite some time and in the industry for many, many years. You're often critical of the word impact and maybe other terms also used in the industry quite commonly. Why is that? I'm not critical about impact investment, probably. I think it's important to make that clear at the beginning. But the word used, Why? Because I think the word impact is a confusing word. It's just too broad. It's all about having an impact, having a change, observing or achieving via your investment a change in the real economy. Of course, you can imagine when you invest into listed instruments, that's quite different from what you can achieve as an impact on the real economy compared to when you are in private markets. Let's dive into microfinance specifically. Tell us a little bit about your personal journey in microfinance. How did you learn about microfinance? How did you enter the space? First I got into contact with this back in 19191 and my first assignment was a job. We had to do a financial sector analysis for multi multilateral institution at that point in time in Costa Rica. So I was learning. My task was to analyse a couple of so-called microfinance institutions. At that time, all of those were not-for-profit. So the whole thinking of commercialization or more profit driven only came a little bit later. And that's a very interesting topic to to come later towards that topic. But at that point in time, these were not-for-profit organization and we analysed those organisations and the results at that point in time was a bit frustrating because all of these institutions which we found in the field were, I would say operationally or from an efficiency level, I think it's fair to say they were highly inefficient. Now the interesting thing to me personally was because I was a young fellow and curious and came Sunday, we always worked Monday through Saturday and Sunday was off. I was for three weeks in the country. Came Sunday, I asked the taxi driver in Costa Rica and said please bring me to the area here in Costa Rica. You have to imagine that's Costa Rica 19191. Bring me to the area where the poorest people live now. And he told me, hey, be very be very careful because you know, this is a bit dangerous going there. I said no, no problem at all let's just go there. And so we went to something let's call it slum like area in the outskirts of Costa of San Jose, Costa Rica. And what I did is I went from one family to the others. They, of course, they all were micro entrepreneurs and I asked them whether they actually had financial needs. What, what, what, what are their needs and did they get financial services? And the interesting thing was that many papers written about that. What I basically saw is that what it means to be excluded from financial services, not having the resources, not having access to any resources which they could make and use of to improve their lives. So some of them got a loan, a credit from a loan chalk, very high interest rate, poor offering. Some of them got from some of the institutions I was analysing they, they got a loan and I asked them, So what does it mean for you? And they said, look, the difference is really they, they got that financing, they complained and I think with all their rights, they complained about the poor service. As I told you earlier, these organizations were, you know, from efficiency level, from operational level. I would never describe them as very efficient at that point. But that was the offering out there. And the people made clear to me, look, though the service is very poor and certainly it has to improve, but it makes a difference for us. If I would have to summarize my whole career now we are in 22,022. So more than 30 years later. It's all about creating those opportunities for people on the ground. When you think about the term like poverty and poverty is a super complex phenomena. Poverty is not a simple thing. And also there's, I mean, it's very naive to think that poverty can be eradicated or can be just in a simple way. No, there are. It's a complex situation and there are so many factors contributing to poverty. But as you know, Xander the Economist has been saying there's one definition of poverty is you're poor when you lack opportunity, when there is no opportunity. Now that very simple definition of poverty. I found that during my whole life very useful because when I have to take a decision on does this make a difference for a person on the ground, I very often think, yeah, but does it create an opportunity which otherwise wouldn't be there? And that, I think, is a very good guiding principle. So after that Sunday in in Costa Rica, Rojos, where you realized on the one hand, the massive need for the solutions that the institutions that you were assessing were providing, but then also the challenges and, and, and the inefficiencies also inherent in the business model. What was your next step? A lot of the development which happens during from I would say the end of the 80s until roughly mid to second-half of the 90s was the establishment of the thinking that that this idea of as these are poor people, it should not be a business is not the right approach. And that's very important under today's perspective. I think most people would or some people would be astonished and say, but you know, of course it can be a business, but but let's go back, we are talking about the poorest people on this planet. Now when you run this on a commercial level, so there is a degree of profitability in that. This means of course people when they get the credit, they have to pay back, of course it's a credit and there's also an interest rate. And as he's a tiny interest rate, and this is probably the most frequently formulated critique towards microcredit or microfinance that the interest rates are too high. Of course everybody would like to see interest rates to be low, but the point is tiny loans, and I don't go to the details here, are costly. So if the institution, so the financial institution wants to cover the cost it has to charge an interest rate expressed as a percentage is relatively high. That was a big, that was a big, if you want so philosophical struggle about this, can that and should that be the case, when you think about it for a moment, you find out it has to be the case in the sense of that only then you can scale the operations up. If you cannot cover your cost, but the consequences, then investors from the public or later from the private sectors are not going to invest even more because those funding sources are limited. If I could stop you there, because I think it's an important, important and, and complex point as you raise the need to cover cost and cost in, in, in this particular space tends to be high. Could you help our listeners understand what drives these higher costs as compared to, for example, I walk into a bank, I have a credit history, there's a branch close by and I can get a loan at a far lower interest rate. Tell us a little bit about why that's not the case. Yeah, in microfinance, think about it. You want to have a credit relationship with a client. Very important here is and it's actually an element of good lending practice. You have a relationship because you have to explain what it is. Very often the borrowers are not educated financially. So the process when you do business with these people, you have to also take on the role to explain what is this about. This is a loan and this loan functioned under certain circumstances. It comes with certain cost. So we consider this and in the industry, I think it's a given these days, of course, that this transparency toward the borrowers is super important. It has an educational element so that the borrower can make up her or his mind on do I really want to have the loan? You have to understand first. So now whether you do that explanation for a loan of$20,000 or you do it for a loan of 200 or is the same explanation. So that means the real problem is that not only explaining to the clients but then processing, you have to analyse a client. You have to get an understanding of is the client actually capable to repay the loan? Does it so to say simply speaking payment capacity and the other is there a repayment willingness? So both of that has to be analysed. It's just given the smaller amount, relatively speaking, more costly. Therefore, when you express it as an interest rate, the interest rate is is higher compared to when you do the same thing for a larger amount. I imagine that especially when you began in in in the early in the early 90s, regulation was also a challenge. This is a relatively new space. As you were saying, there were competing visions on to how this space should be regulated or not. Tell us a little bit about the challenges in that in, in in this area for the non expert in the field. If you want to establish a banking institution, I'm, I'm using the term banking here. Generically a banking institution, even if that institution would only like to work with small entrepreneurs or micro entrepreneurs. You need a license for very good reasons. You need a license because a banking institution, as we all know, is allowed to take deposits from clients and is allowed to extend loans to clients. Now it's a people's money. So people have to know that when they save money in the formal financial sector, and we are talking here about the formal financial sector, that someone, typically the banking supervisory agency made sure that this institution fulfills certain minimum requirements. Now when you imagine that I give you an example of a Latin again here, a Latin American country and we can later switch to Africa and and Asia, but structurally it is not different. Back in the 70s, eighties of the last century, you came to whatever developing country and, and you could pick any of those. You would see there are banks, a couple of banks, sometimes state owned banks, sometimes privately run banks. Typically and I'm not exaggerating, they were serving probably the upper 10 to 20 or 30% of the population. When it come the larger companies, the state owned companies and the more wealthy people in those countries. A lot of people were excluded at that point in time. Now the question is then if you want to change that, you you need more, more financial sector institutions. But if you want to establish a bank with good reasons, there's minimum capital requirements. And these minimum capital requirements have a lot to do with what the bank actually is allowed to do. Now for somebody who wanted to open bank or even a non banking institution, non banks is also a term for a regulated company, but which is typically not allowed to take deposits. So the funding comes for example from investors like responsAbility, like also the public sector organizations and extends financial services, but doesn't take any deposits at that at that very beginning if you want to do that, but you have to show that you have a certain minimum capital available. Now the minimum capital requirements very often in countries are so high that nobody can basically establish a new bank. So it it doesn't happen. So therefore regulatory wise two things were needed at that point in time. 1 is that some countries and here very prominent is Bolivia, very prominent is Peru at that Peru and Bolivia really at that point in time were front runners in coming up with adequate regulatory frameworks which allowed groups of people to establish for simplicity let's call it a non banking institutions, but to be a regulated entity. Now imagine, imagine the difference it makes for a sector development. Whether you are dealing with a non regulated entity or you are dealing with a regulated entity, that makes a huge difference. So I go back to the 90s. In the 90s, one thing which happened I mentioned earlier is change of mindset. Actually it's not only allowed to do business with poor people, it's if you want to scale it up, it's needed. And actually also if you treat and you think about poor people in these countries as not on the same level as you, not clients, you basically you already are thinking, but no, they are actually depending on somebody. No, they are not depending. They just need adequate services. So one is the mindset of the mind, the mind shift of really understanding that, OK, these are clients out there and they want to be in business as anybody else. At that time, the German government actually or actually it was a part of the German private sector, what they did in German, in Germany, I'm German, they are in Germany. We have what we call Spark Cussen. Here we are talking in Switzerland, it's cantonal banker. So Sparkhasser is a banking institution owned by a city or cantonal banken is a bank owned by Canton. Not to say what the foundation of Sparkhassen in Germany did in Peru is they implemented the law for the establishment of spark saving institutions in Peru. Now they were owned by the cities, not the private sector. And what happened at that point in time is that basically, you know, they got support, some advisory support and consultancy report, a whole system of financial intermediaries which goes back to the 80s, late mid 80s, late 80's, the last century has been emerged. And actually, sometimes I say that's probably the most successful financial sector development or microfinance initiative worldwide. Because today when you come to Peru, 30 years later, you will find that these sparkasm the savings institutions, you find them across the whole country. Of course, these days now they are mainstream institutions and they still serve micro entrepreneurs, they serve small companies, they serve large companies. They have developed into fully fledged financial service providers. It's actually a very beautiful story when you look into this. That's what it always meant when we talk about financial sector development in the very, very early days of the savings companies in, in Peru, you know the, the savings institutions, they had only two services when they started. One service was deposit. So you could go in and you could open a bank account with five or two solace. So the Peruvian currency basically, I don't know, $0.10, you know, they, they allowed to open an account. But imagine you never could save your money in a formal place so far. And now you could go into the bank and you could open a bank account. That was a very big step forward. And the second product was a so-called a pawn loan. You, you came into the bank and you brought your gold and you see the bank was very risk averse. At the very beginning I said only when I get the loan, I get the real collateral, then I can extend the loan. So it was a very primitive service. So don't misunderstand me, I'm not defending this. I'm just explaining how people try to basically come up with some financial services for people. And of course, when you take deposits, you have to make sure that you manage the risk adequately. And, and there was not this broad experience which is available today when we talk about landing to micro entrepreneurs and, and, and, and small, small entrepreneurs. It reminds me of one of my first experiences at the company actually when we were in Peru meeting the, the, the team in Lima And they were talking about their knowledge of the industry and they talked about these Germans that were advising and building up a framework. And it was striking to the team present that you were one of those Germans. I have been working as a consultant for, as they called the Kahas Municipalis in the 90s. But institutions already, couple of them had been established and my job at that point in time, I was actually implementing cost, cost management system for them. Because here again we are back to the question of cost. The biggest movement very similar in thought to what later was microfinance has been the cooperative system. Because cooperatives back in the 18th, you know, 19th, sorry, 19th century, yeah. So the cooperative system is nothing else. When I talk about the financial part of it, cooperatives of course you see them in many are, they can be producer cooperatives, all type of cooperatives. But in the financial sector, the thought of a cooperatives of course is a reaction towards 2 elements. One element is no access to financial service by the other players. That's a key thing. So the farmers, therefore we see so many cooperatives in rural, the farmers, just the rural areas were excluded from all financial services. Therefore, we see in Germany, we see in Switzerland, we see in Austria, but we see then in many other countries the thought and kind of OK, if the financial sector does not offer, we have to self, we have to organize our self. And the second, the second thought, thought which is is important there. And then how to do that when there is nobody providing the capital? We provide the capital ourself and we are the owners of the company. And so you have the cooperative structure where the farmers themself are the owners of the institution. And the interesting part, as we all know in most cooperative, not all, but in most cooperative system is kind of one person, one vote. So it's not the capital. So they have a these two thoughts. So the cooperative systems have been clearly historically part of the answer towards that problem, but there are no financial services for a large part of the population. And so people helped themselves and they came up with these systems very often. Of course, now when you, when we came, when I came first to Costa Rica, I mentioned Bolivia, I mentioned also Peru, There were already cooperative system also in place. Unfortunately, I have to say because some people get when it comes to cooperative systems, a bit romantic, which I'm personally not. I think these are great success stories. Look at Germany, look at look at many countries. Unfortunately, there are also many countries where cooperative systems failed. Also, it's not like the easy solution or the better solution. And even what some people don't want to talk about when you come to emerging markets and you, you, you see cooperative system that it's not always like the service is financially speaking, always better. Sometimes you see cooperatives and because they have the same restrictions and, and they just, they, they see, but there's cost and they have to cover cost because they take the deposits off their members. And so they have to make sure that the capital which the members provide is actually used in in the in the right way. 150 years back, basically local people made local funding available and it was all, if you want so directly impact because it was just invested into local activities. It always had an impact on the real sector by definition, by definition. Now, one of the things I really like about your perspective, Rojos, is that, you know, often in, in, in this space, people have a sense of the saviour complex, right? We're going to come in and, and, and, and show, let's say, poorer people how, how to do things. We're going to lift them from poverty. But you take a very different perspective. You say, look, these people know how to help themselves. What they're missing is that initial opportunity. And that seems to be the bedrock of, of of your philosophy. Would that be, would that be a Fairview as a global community, we, we can do is to create more equally distributed opportunities, correct people, I think probably I can say we have a tendency sometimes to look too strong from our perspective. And as the sector increasingly becomes mainstream technology Fintech, right. These are new business models that are disrupting a little bit that proximity, that ability to have a relationship with the client at hand. But at the same time they present tremendous opportunities well to reach previously excluded people. How do you think about Fintech? What are its key challenges? What are the opportunities that you see? I think it's fair to say that in the end, technology is related to cost. Now it's about bringing cost down. When you can bring cost down, you will automatically have higher levels of inclusion. Tell us what's next for microfinance in this space? What is the most important lesson that your past has taught you? I can tell us something about the future. In 20 years. There is also more choice and opportunity for the investors. That is very important because don't forget, yes, we responsAbility we started and we are very different in this sense from most of our peers. We started with a retail product. So you can walk into a bank in Switzerland and can invest$1000, let's say in microfinance that that's what we started with. Most of our peers and most of the offerings still today, 2022 are offerings for either institutional investors or are there for ultra high net worth individuals. So to get so to say qualified investors, but the people like us are let's say retail investors and for retail investors, it's still in impact investment. The big challenge to make investment opportunities available for good reasons. Again, on the regulatory point, I'm again not saying please open the gates and everybody can invest in everything. I'm not saying this. What I'm trying to say is there are reasons related of course to consumer protections. Why is this limited? But personally, of course, I have the hope that we can find better ways to also broaden the investment opportunity range for all type of investors over the next 20 years so that people can pick those investment opportunities even in the much more personalized way than they can do that today in the private market. Don't forget, I'm talking about private markets when we talk about public markets. So listed instruments, that's a very different thing. You can buy a share of any company who's listed and that's of course has been developed. But the listed, the number of listed companies is just one part of the total. And specifically when we talk about emerging economies, the largest number of players is non listed. Yeah. And so the the private markets are still and will be very important. Thank you everyone for listening to this Part 1 of the series on impact investing with an expert of many, many years, Rojas Mahmatz.