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(;(&87,9(6800$5< Businesses face growing pressures to combine profit maximizing behavior with concern for social impact in a so-called ‘double bottom line approach’. Private businesses which seek to integrate their profit making and social intentions are usually thought to be dynamically unstable: stunted in their growth and vulnerable to single-minded competitors on the one hand; and diluted in their social impact on the other. Development banks are financial entities which seek social impact while remaining solvent. State ownership is often required to provide a risk underpin because of the vulnerabilities of inhabiting this wasteland: to date, there have been few examples of privately owned development banks of any size or longevity.

This paper focuses on three privately owned development banks on three continents—Plantersbank (Philippines), ShoreBank (US) and Triodos Bank (Netherlands). From the outset, these banks have explicitly intended to have a positive social impact in underserved banking niches in their respective markets, and yet also to produce at least positive real returns for shareholders. This will be called a ‘strong double bottom line’ approach. Using conventional measures of financial and social outcomes, this paper shows that these banks have achieved positive social impact while also surpassing their peers in financial performance.

The paper argues that the paradigm of private development banking demonstrated by these three banks is highly relevant to reaching the global poor. Building sustainable and robust retail financial service markets in developing countries will in many cases require a deliberate double bottom line approach if it is to be successful and sustainable. Privately owned and run development banks such as these three are well placed to do this.

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,1752'8&7,21 There are growing pressures for businesses to combine profit maximizing with a concern for their social impact. This so-called ‘double bottom line approach’1 amounts at a minimum to making business more accountable for its impact on society. Since the time of Adam Smith, the two bottom lines have traditionally been seen as aligned—at least in theory, since special conditions are required for this result to hold. In practice, businesses are increasingly forced at least to consider the social and environmental impact of their activities.

CK Prahalad’s recent work (2004) has highlighted cases of large profit maximizing firms which nonetheless have positive social impact on low income people. But is the converse possible? Can businesses which seek social impact first nonetheless survive, let alone thrive, as private businesses over time?

Privately owned firms which seek to blend their social and financial motivations are usually thought to be dynamically unstable: stunted in their growth and vulnerable to single minded competitors on the one hand; and diluted in their social impact on the other. Development banks are financial institutions which seek social impact first while remaining solvent, and are perhaps an extreme example of this vulnerability. Most often, state ownership is required to provide an underpin to the risk; or else, the development banks which offer retail services, like postal savings banks, stay away from lending in favor of savings and payment services only. There are few examples of successful privately owned development banks of any scale globally.2

Contrary to this norm, this paper focuses on the example of three privately owned development banks on three continents—Plantersbank (Philippines), ShoreBank (US) and Triodos Bank (Netherlands). These banks have explicitly had the intention from the outset to have a positive social impact in underserved banking niches in their respective markets, and yet also to produce reasonable positive returns for shareholders. Using conventional measures of financial and social outcome, these banks have in fact achieved exceptional social impact while also surpassing their mainstream peers in financial performance.

This paper introduces these three banks and assesses their long term performance in social and financial terms. The core argument of this paper is that

1 In fact, all three banks in this paper have a ‘triple bottom line’ where effect on t he environment is also measured and assessed; but this paper focuses primarily on social impact , hence t he narrower reference to double bottom line. 2 For example, t he World Savings Bank Institute, which is an association for banks committed at some level to a double bottom line, has 101 members, almost all of which are state owned; and many focus only on taking retail savings without providing any credit . Co-operative banks in some count ries are notable exceptions, alt hough these are restricted to members only. Ot her notable exceptions which deserve further research are t he giant Bangladeshi microfinance NGOs such as BRAC or ASA which have been consistently profitable and yet have great impact on the wellbeing of their clients.

2 Draft 2.1 these banks demonstrate by their example that it is possible, though not easy, to manage successfully the tensions between achieving social impact and making profit over time. Through their example, a paradigm emerges of private development banking as an example of what will be termed a ‘strong’ double bottom line approach to business.

None of the banks presently serves the global poor directly as a core business, although their indirect interests in microfinance in poor countries are already substantial and still growing. The paper argues, however, that their paradigm is particularly relevant to providing financial services to poor people globally.

The paper is structured as follows. Section 2 creates the theoretical framework for the double bottom line concept and describes how it can be measured. Section 3 then introduces the three banks; and Section 4 assesses their performance, both social and financial. Section 5 explores the tensions inherent in their approach, and how they have been managed over time. The conclusion returns to the question of the relevance of this approach to the business of serving the global poor.

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This section builds a simple apparatus to depict double bottom line business in the context of the traditional roles of business and charity3. The emerging hybrid organizations, of which the banks in this paper are an example, are then located in this framework.

A key distinction is drawn between H[DQWH intentions and H[SRVW outcomes. Each is considered in turn.

,QWHQWLRQ Businesses are traditionally characterized as entities which seek first to maximize return to shareholders. Representing the mainstream view, Dobbs (2005) says in a recent 0F.LQVH\4XDUWHUO\6SHFLDO(GLWLRQ, “..the tumultuous recent past has reinforced two fundamental beliefs. The first is that the business of business is to maximize it shareholder value by increasing its intrinsic value.” Businesses may nonetheless achieve positive social outcomes as a by-product while they pursue profit. This does not change their prime intention, however.

Conversely, charities seek first to maximize their positive social impact. They may, however, be constrained to earn revenue sufficient at least to break even and sustain themselves.

In theory, there exists a continuum of weighted intentions between the polar cases of 100% profit seeking, and 100% impact seeking. The dashed line in

3 Whether delivered by the state or non-government organizations.

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Figure 1 below indicates all the possible mixes: for example, at the centre point as shown, an entity may choose to weight its objectives equally in terms of financial performance and social impact.

With the precedent of strong and weak economic hypotheses, we may distinguish a ‘strong double bottom line zone’ (‘strong DBL’) around the midpoint, in which both intents are heavily and deliberately weighted; and two ‘weak double bottom line zones’ above and below the strong DBL zone. In the weak DBL zones, one intent is either heavily subordinated to the other; or else is to be achieved as a by-product of the other. Hence, a business which combines profit maximization with (i) a ‘do no harm’ approach to social impact and (ii) which produces positive social impact as a by-product only, would fall into the weak double bottom line zone at the bottom.

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In theory, a business could choose to locate at the midpoint shown, equally balancing both intents. In practice, however, there are a number of forces which create a slippery slope around the mid-point, so that the only stable options appear to be within the ‘weak’ zones. Competitive forces alone should ensure that firms which are not burdened by the added cost or diluted focus of two bottom lines can take business from those which are. Fear of this effect will limit access to capital for non-profit maximizing firms. As a result, they will be stunted in growth and probably unsustainable over time. That there is ongoing debate over whether social responsibility investment is necessary or even desirable illustrates this point: if this investment (which averages close to 1% of profit

4 Draft 2.1 among Fortune 500) is questionable, how much more questionable is say, a blend of intention which includes less than 99% weighting on profit maximization?

Equally, non-profit entities with social missions have faced increasing pressure to generate revenue.4 Foster & Bradach (2005) account for these pressures in a recent HBR article entitled “Should nonprofits seek profits?” From their observations of non-profits which also seek to produce revenue, the authors conclude: “…executives of nonprofit organizations should not be encouraged to search for a holy grail of earned income in the marketplace. Sending social service agencies down that path jeopardizes those who benefit from their programs— and it harms society itself, which depends for its well being on a vibrant and mission-driven non-profit sector” (p100). In other words, the stable point for a charity is towards the end of the intention line, in the ‘weak’ DBL zone.

In practice, therefore, the line representing the possible weightings of intentions may be more virtual than real for much of its length, with small locally stable zones at either end: hence, it is dashed in Figure 1.

2XWFRPH In addition to having distinct intentions, business and charity should be distinguishable H[SRVWby their outcomes. A firm that intends to maximize shareholder value proves its intention by delivering financial results which at least match its peer group over time. Peer performance is generally the only benchmark available for measuring whether profits were in fact maximized. If a firm consistently underperforms its peers, then it will lose value; in time, it either will fail or become vulnerable to takeover by more successful firms.

Financial performance is relatively easy to measure, once the yardsticks are agreed. McKinseys’ recent research (Dobbs & Koller 2005) suggests that the two best measures of long run financial performance are compound revenue growth and return on invested capital. These will ultimately drive shareholder value.

Similarly, social impact can be measured, although this is generally much harder to do. It has taken time for a common nomenclature around impact assessment to emerge, as shown in Figure 2 below.

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4 Despite t he pressures on non-profits to generat e revenues, Foster & Bradach show that t he percentage of earned income in total income reported by US non-profits has not changed much between 1977-1997.

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GOAL INPUTS ACTIVITIES OUTPUTS OUTCOMES ALIGNMENT

What What Results Collection How well you you do that are of all outcomes put in measured results align with intended -- What goals would have happened anyway = IMPACT

Source: Rockefeller Foundation and Goldman Sachs Foundation (2003), Appendix A.

The difficulty with social impact assessment is that it requires not only the measurement of social outcome but also the specification and measurement of an alternative comparable state, in which there was no intervention. Only the difference between the observed and alternative outcome can be attributed to the intervention in question. Clark et al (2003) have produced a catalogue of the strengths and weaknesses of the various methodologies of social impact assessment in use. Most are relatively new and have been used on a relatively limited scale. They suffer from a further weakness: only three of the nine listed allow monetization; that is, the statement of impact in a quantitative form comparable to financial return. The social impact ‘bottom line’ is therefore often seen as vague and fuzzy by those used to regular, rigorous disclosure of performance against quantitative benchmarks.

Nevertheless, it is possible to develop the simple apparatus of Figure 1 to capture possible outcomes as well as intentions. In Figure 3 below, each axis now also measures performance, expressed as a percentage of a benchmark in order to keep the same units as before. Hence, as an example, 100% performance on the financial axis means achievement of a market-average profit performance; 150% means over achievement by 50% and so on.

There is good reason to believe that the shape of the outcome line, or frontier, on these axes is convex, as reflected in Figure 3, rather than straight as shown for intentions in Figure 1. The convexity reflects the fact that the trade-off in outcomes between the two bottom lines may not be one-for-one. Rather, forsaking some financial return may bring social impact greater than the financial return forsaken; and conversely. For example, consider again social responsibility spending. This represents a small move away from a pure profit

6 Draft 2.1 maximization position, but the return in terms of social impact may well exceed the 1% profit foregone; or else, it may yield positive financial benefits too (for example, in terms of brand or positioning) so that the net cost is less than 1% anyway.

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CK Prahalad (2004) in 7KH)RUWXQHDWWKH%RWWRPRIWKH3\UDPLG has gone further than simply arguing that the outcome frontier is convex in this space. Essentially, his argument is that large corporations can innovate in ways which reconcile profit maximizing behavior with achieving large social impact. This can be represented as a vertical line from the profit maximizing point, indicating that there may be no tradeoff for at least a local portion of this line. However, how far this vertical portion extends is unknown, not least because the long run profitability of some of the innovations by private businesses mentioned in the book (such as Cemex in Mexico or ICICI Bank in India) is not yet demonstrated.

In terms of Figure 3, development banks would traditionally intend to locate in the strong double bottom line zone, perhaps closer to the social impact intercept of the intention line. However, all too often, state-owned development banks which engage in lending suffer from inefficiency or corruption; or, in other words, their performance falls below the outcome frontier. However, as Section 4 will demonstrate, not only have the three banks in this paper achieved positive social outcomes, but they have in many respects exceeded the long run financial performance of their profit maximizing peers. This indicates that the outcome line may indeed be vertical, or indeed, even outward sloping, into the strong double

7 Draft 2.1 bottom line zone: in other words, further than the so-called ‘Bottom of the Pyramid’ cases so far demonstrate.

More importantly, this paper will argue that example of these banks shows that the ‘strong double bottom line zone’ is habitable for businesses, and in some cases, may even become a highly desirable over time. How these banks came to inhabit this zone, and then sustain their position over time, are the subjects of the rest of the paper.

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The three banks which are the subject of this paper are quite different in certain ways. As the summaries in Box A below show, one (Triodos) operates internationally through branches in four European countries; another (Plantersbank) operates nationwide in the Philippines through an extensive branch network, while the third (ShoreBank) has a banking presence only in four US states. However, it is their core similarities which make them the subject of this paper. Chief among these is a strong and enduring commitment, as privately owned entities, to achieving social impact while making a profit. The meaning and outcomes of this commitment will be examined further in subsequent sections.

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3ODQWHUV%DQN3KLOLSSLQHV ZZZSODQWHUVEDQNFRPSK was started in the 1960s as a regional development bank. Jesus Tambunting and colleagues bought it in 1972. Renaming it Planters Development Bank in 1976, they refocused the bank on lending to small and medium businesses in the Philippines which did not then have access to bank credit. Thirty years later, Planters Bank is the 23nd largest bank in the Philippines, with assets of over US$600m. Although its product range has broadened to include treasury and cash management products, it continues to focus on the niche of SME lending. It has won numerous awards and has one of the highest proportions of foreign shareholding among Philippino banks.

6KRUH%DQN&RUSRUDWLRQ&KLFDJR86$(www.sbk.com) was formed in 1973. The early story of ShoreBank has been told in a 1991 HBR article by co-founder Ron Grzyinski (“The New Old Fashioned Banking”) and in a HBR book by Richard Taub called &RPPXQLW\&DSLWDOLVP. Today, ShoreBank Corporation is a privately owned bank holding company with over $1.6bn in assets, banks in African American and rural communities in several US states and an investment fund Shorecap which is presently investing in local development banks in developing countries. ShoreBank’s core bank in Chicago earned a return on equity of 15% in 2004, which places it well ahead of most of its size group peers in the US, while it continues with its mission of serving underserved local borrowers and groups, including minority housing developers, faith-based institutions and small businesses.

7ULRGRV%DQN1HWKHUODQGV ZZZWULRGRVFRP was set up in 1980 following the earlier establishment of the Triodos Foundation in 1971. The Triodos Group currently has a balance

8 Draft 2.1 sheet of US$2.25 billion, on which it showed a profit in 2004 of US$4.5m. In addition to the Netherlands where it was started, Triodos Bank is directly active in three other European countries (Belgium, UK and Spain). In these countries, Triodos focuses on financing companies and organizations that contribute to a better environment or that generate social or cultural value added. Through the off-balance sheet funds it manages, Triodos Group is directly involved in investing in microfinance institutions in many parts of the developing world.

There are further relevant similarities shown in Table 1. All three have been in existence for three decades or more; they are medium sized banks by most definitions, with asset bases ranging from $600 million to over $2 billion; and are profitable and growing. Their main clients are small and medium enterprises (SMEs), although they all have significant interests in micro-enterprise finance.

Each has evolved from a different starting point, reflecting differences in local context. In all, entrepreneurs have played an important role in the birth and development. œ In the Philippines, Jesus Tambunting, founder and Chairman of 3ODQWHUVEDQN, was a convert to the social impact of banking. With associates, he bought a neglected development bank and discovered that there was both opportunity and need in the neglected SME sector in that country. In his own words: “Because of the bank’s small size and the provincial location of its first offices, we had no choice but to cater to the small businessmen and entrepreneurs in the region. But what started as a necessity soon turned to meaningful and gratifying work. Dealing with the small entrepreneurs opened my eyes to the wonderful realization that we were making an impact where it counted most— with the marginalized sectors and the small entrepreneurs in the countryside….our plan changed from growing the bank and becoming like other commercial banks to focusing on SMEs and proving that they are viable propositions…And we vowed that no matter how big our bank became, we would always stay committed to SMEs” (Speech to MAP Inaugural Meeting, 26 January 2004) œ 7ULRGRV %DQN was started by a group of four Dutch men who had been discussing for a while how to handle money in a socially conscious way. In 1980, they formed the bank as a way to put the discussions into practice. Triodos has long been involved in supporting environmentally friendly small businesses. œ More like the founders of Triodos, four American bankers were dissatisfied with the way in which conventional banking was contributing to urban blight in Chicago’s poor South Shore district in the early 1970’s. Together with other funders, in 1973 they bought South Shore National Bank, today called 6KRUH%DQN and refocused its operations as a neighborhood bank. Two of the original four founders still run ShoreBank Corporation, the group holding company, today.

7DEOH%DFNJURXQGLQIRUPDWLRQ Name 3/$17(56%$1. 6+25(%$1. 75,2'26%$1. &25325$7,21 *5283 Date of formation 1961; present 1973 1980— Bank formed;

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stockholders acquired Foundation started in ownership in 1972 1971 Countries of Banking: Philippines Banking: USA Banking: operation Private equity Netherlands, UK, investments in Belgium, Spain. developing countries Funds invested in 40 developing countries Ownership 40% foreign institutional 75 private shareholders 8349 holders of investors; (individuals, corporations depository receipts in Management controlled and foundations) in the Foundation which bank holding company owns the bank; 37% which owns 100% of the held by 14 institutions underlying banks Mission “Plantersbank is “ShoreBank invests in “To finance statement thewhole heart and mind people and their companies and partner of Small & communities to create organizations that Medium Enterprises and economic equity and a contribute to a better Professionals. We help healthy environment” environment or that them succeed by generate social or providing funding, cultural added value. financial return and ..(to) offer savers and management advice. In investors a way to so doing, we are a key use their money to contributor to the support these development of the initiatives” Philippine economy and of the communities we serve.” Market focus SME lending Lending: Small businesses Treasury œ Community which are socially Cash management development and environmentally Savings investment friendly Housing loans œ Enterprise: Small landlords for rehab œ Faith based lending

Microfinance Formed Micro Enterprise In 2003, formed and now Manage several activities Bank in 2000, which manage a private equity private equity funds serves over 3000 micro fund, ShoreCap, of of around $65m with clients from branches in $28m; to date, invested investments in micro- Mindanao in 5 SMME banks in enterprise institutions developing countries, in 40 countries, with which serve over 192 2.7m clients in total 000 borrowers

5 $620m Bank $1.48bn Bank $1.28bn Size (2004) rd (Gross Assets) (23 largest in Group $1.66bn Group $2.25bn Philippines of 42 commercial banks and 91 thrifts)

5 Here, and elsewhere, exchange rat es used for conversion are: 1US$=54 Ph.Pesos and 0.8 Euro.

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As private financial institutions, all three recognize the importance of profit but do not pursue it single-mindedly. For example, Triodos Bank states6: “… Profit is not everything. It is however an essential test of a company’s efficiency and ability to build reserves in the future and to achieve an acceptable return for investors. Profit is, of course, also an important source of investments for new activities and developments.” The other two banks would agree. All three have an explicit developmental mandate to make positive social impact. This not externally imposed, however, but rather internally generated and sustained.

In structure, both ShoreBank and Triodos have a holding company or trust which controls the operating bank/s. As a result, the activities of the core bank/s which are the main investment of the holding entity can be ringfenced from other activities undertaken by the broader group. For ShoreBank and Triodos, these activities include international fund management; and for ShoreBank at least, international consulting and community development activities. Plantersbank itself directly holds stakes in affiliated businesses, such as Micro Enterprise Bank.

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Over very similar life spans (1970s to the present), each bank has independently evolved its own double bottom line philosophy. Each manages its performance in terms of this philosophy.

6RFLDO,PSDFW For Plantersbank, development impact comes primarily through its conscious decision to restrict its market focus to small and medium enterprises; indeed, this focus is at the core of the bank’s identity. This niche was originally neglected by other Philippino banks, which found tempting markets elsewhere serving larger corporate customers. Today, partly as a result of its demonstrated success, Plantersbank faces more competition at the higher end of the SME market. The bank currently measures its social impact by the number of clients served, some 8,000 at end 2004. Its annual report regularly carries the stories of the individual entrepreneurs making up this number who have grown their businesses with Plantersbank funding.

ShoreBank’s philosophy is rooted in a fundamental belief about the role of banking. As Chairman Ron Grzywinski stated in 19917: “Of a bank’s three primary responsibilities— to protect deposits, to earn a reasonable return on invested capital and by recycling the savings or the community to contribute to its economic growth and vitality— bankers in general do a good job of the first and second and a poor one on the third.” Banks play a vital role in supporting local

6 Triodos Annual Report 2003:21 7 Grzywinski 1991:96

11 Draft 2.1 business and property markets, especially when areas become economically depressed. Grzywinski again8: “Deliberate, disciplined development banking in a disinvested community can revive a local economy, rekindle the imagination of its people and restore market forces to their normal health and interdependency.” ShoreBank has played this role demonstrably in the South Shore community of Chicago. At a time when other banks were disinvesting by red lining the area for further mortgage lending, ShoreBank provided loans. In the process, it created a new local market niche: financing the acquisition of multi-family rental buildings by small local landlords who rehabilitated and rented out the buildings to low income tenants without any public subsidy. This product line is the most profitable in ShoreBank’s loan portfolio today and has produced to date 47 000 units of improved rental housing. The portfolio also includes loans to small businesses and to faith-based and non-profit organizations, which stabilize the social fabric of a community.

ShoreBank monitors and reports what it calls ‘community development lending’: loans to designated priority communities, to minority-owned companies and faith- based and other non-profit organizations. Its benchmark is delivery of new loans annually in excess of twice average capital, with recent performance in excess of three times. In 2004, ShoreBank reported that its cumulative community development lending had exceeded $2 billion.

While ShoreBank measures its impact in geographically defined communities, Triodos Bank carries on banking business across a range of geographies. However, more like Plantersbank, Triodos restricts the type of business which it will fund. As its website declares: “Triodos Bank only finances enterprises which add social, environmental and cultural value— in fields such as renewable energy, social housing, complementary health care, fair trade, organic food and farming and social business…We do this with the support of depositors and investors who wish to contribute to social justice within the context of a more sustainable economy.” Of outstanding loans at the end of 2004, loans associated with culture and society made up 41%, nature and environment 34% and social business 21%. In common with the other banks, the annual reports of Triodos also highlight pictures of clients supported by its loans.

Triodos sees its social impact in more general terms: it “… is actively engaged in finding positive solutions to social problems where money in general and banks in particular can play a significant role”9. To Triodos, sustainable banking means not only supporting sustainable development but also offering competitive products to its clients, innovating those products and engaging in public debate about the benefits and challenges of socially responsible banking.

8 Grzywinski 1991:95 9 Annual Report 2004:7

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While all three banks value transparency and report comprehensively10, their assessment of social impact derives directly from the business filters which they use: since they do only a certain type of business with positive spillovers for society, they count all business in this category as socially beneficial. In other words, their reporting is much more about inputs and outputs than outcomes, still less impact. Outcome reporting tends to be anecdotal, as exemplified by the pictures or stories in annual reports, although there are emerging exceptions in their groups as Box B below shows. This is no different from the social impact reporting done by larger financial institutions today. What is different about these three from conventional banks, however, is that all, rather than only some, of their business can be categorized as having at least some positive social impact.

%R[%0HDVXULQJ7DUJHWHG2XWFRPHV6KRUHEDQN(QWHUSULVH3DFLILF Within the ShoreBank group, a small Community Development Financial Institution called Shorebank Enterprise Pacific (SEP) in Ilwaco, Washington, has made the most progress in designing and implementing a holistic performance management framework which tracks social and environmental outcomes with hard data points. SEP was formed in 1995 by ShoreBank Corporation and Ecotrust. SEP’s mission is to promote economic opportunity and a healthy environment for the communities of coastal Oregon and Washington. Its investment products include a revolving loan fund, federal tax credits, a product development fund, and professional consulting. As-of August 2005, its investments totaled $30m. SEP has developed a metrics system that integrates economic, ecological and social equity outcomes into its performance management— hence the name “3E Metrics”. As SEP’s website says, “We have learned to measure the direct results of our work, rather than the theoretical or eventual impacts because it keeps us focused on and accountable for results, not theories.”11

The theoretical framework for their 3E approach was developed over three years and first implemented in 2004. SEP recently completed an independent external audit of their 2004 3E metrics that yielded the preliminary results shown below.

ECONOMIC ENVIRONMENTAL EQUITY E1a: Number of jobs E2a: Linear feet of functioning E3a: People of color and women created and/or retained riparian zone entrepreneurs assisted MREV IHHW EXVLQHVVRZQHUV

E1b: Leveraged third-party E2b: Acres of land in E3b: Number of natural-

10 Triodos, for example, uses Global Reporting Initiative standards which emphasize triple bottom line reporting and is encouraging its microfinance affiliates worldwide to follow. 11 From: http:/ / www.sbpac.com/ bins/ site/ templat es/ subtemplat e.asp?obj ectid=C6563160%2D4&area_2 =Our+Story%2FMetrics&NC=9557X

13 Draft 2.1 investment sustainable management resources-dependent families 00 DFUHV assisted IDPLOLHV

E1c: Secondary Value E2c: Gallons of water not in E3c: Dollar value of services Added waste stream delivered to low income people EXVLQHVVHV JDOORQV 00

The audit has led to further refinement of the metrics: for instance, the substitution of “land tenure,” i.e. local ownership or control of real property, for one of the social outcome metrics (E3c) on the grounds that it was duplicative.

SEP’s major learnings are 1) triple bottomline metrics must be location and business-model specific; 2) metrics must reflect outcomes that the business can ‘touch;’ and 3) managing triple bottom line goals is a process, not an event. The metrics must reflect outcomes that are realistic, achievable, and that lead to desired impacts over time.

The audit report states that in the view of John Berdes, Managing Director of SEP, “the effort to craft a set of 3E metrics that support our mission might also be called an attempt to ‘monetize place’.”12 At the same time, this measurement system provides a model that can be customized for other locales and industries and is likely to foreshadow similar efforts by the rest of the ShoreBank group.

As noted earlier, defining, and then measuring, social impact is hard to do properly: it requires the definition of a counterfactual scenario, and then collecting social indicators to measure against the actual outcome. All three banks accept that they can do more in this respect.13 ShoreBank has recently developed a Theory of Change framework in which the indicators of targeted positive social change are set for each business unit according to its local business conditions. These indicators will be monitored over time so that outcome can be measured in future. This at least brings social impact onto the same level as the other ‘hard’ or quantitative objectives like return on equity. As the supply of socially responsible investment grows14, so the need for an independent evaluation of social impact will grow too.

)LQDQFLDOSHUIRUPDQFH The two measures of long run financial performance suggested by McKinseys— return on equity and compound growth in revenue— are used in Table 2 below to compare each bank against a defined peer group. Comparison among the three

12 “ Measure What Matters” , Cate Gable, Axioun Communications, July 2005, p.10. 13 The Chief Executive of ShoreBank, Mary Houghton, participat es in the Development Finance Forum which published a monograph called Capit al Plus in 2004. A full chapter is devoted to the need for bett er accountability and social impact assessment 14 The Social Investment Forum reports that in 2003, over $2 trillion was count ed as socially responsible investment in the US, double the 1997 figure.

14 Draft 2.1 banks is not meaningful as their contexts are vastly different in return and growth profiles. Since banking revenue is driven in part by asset growth, an asset growth measure is shown as well.

7DEOH0HDVXULQJILQDQFLDOSHUIRUPDQFH Peer performance shown below each number in brackets; a boldface number above the bracket shows that the figure exceeds the peer group figure

Plantersbank ShoreBank15 Triodos Shareholder return on equity   4.0% (annual average (5.0%) (14.2%) (9.2%) 1999-2004) Annual growth in 16 revenue    (1999-2003) (2.2%) (6.4%) (8%) Annual growth in gross assets  12.3%  (1999-2003) (5.7%) (12.8%) (10%) Peer group Philippine commercial US bank peer group 4 Dutch co-operative banking sector by asset size ($1bn- banks: Rabobank, $10bn), regionally and SNS Bank, Friesland nationally Bank, ASN Bank17

Table 2 reflects a group of banks which have by most measures achieved financial performance outcomes in excess of their peers.

In the past five years, all three banks have consistently grown two to three times faster than their peers in terms of revenues. Two of the three have also grown assets faster, which for lending banks, generates most revenue. The third, ShoreBank, has almost matched its national peers in asset growth, and exceeded the growth of same state peer banks.

15 The ShoreBank data is for the core Chicago bank only, which comprises 89% of group assets, rather than for the group holding company. The holding company, ShoreBank Corporation, does not have a comparable peer group. The group struct ure is explicitly used as a means of managing and redistributing ret urn in t he group; indeed, it was changes in US banking regulations in the 1970’ s which allowed ShoreBank Corporation to serve as a community development corporation which int er alia owned a bank. However, it is important to note t hat the main subsidiary bank pursues t he same development banking approach as the group as a whole. 16 Where revenue is defined as adj ust ed operating income, which is total revenue (interest and fee) less int erest paid 17 The Dutch co-op banks differ from Triodos in geographic market focus, age, size and especially mission, but represent the closest peer group against which Triodos can be compared.

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At the level of return on equity, both Plantersbank and ShoreBank have exceeded the recent five year average of their peers.18 This has been consistently achieved, rather than through a few years of exceptional performance: Plantersbank’s profitability has exceeded the volatile Philippino bank average in all but two of the past ten years; and in those two years, it has equaled them. ShoreBank has shown a steadily increasing level of profitability since establishment, exceeding its US peer group in each of the past three financial years, having come very close in the preceding three years.

In the case of Triodos, average return on equity is under half that of its peer group, but is at the target level of 4% used as guidance by the board and board over this period. Triodos openly states that it prioritizes “above all, stable returns”, rather than the level of return SHUVH. Using the standard deviation of Return on Equity 1999-2003 as a measure of earnings stability, Triodos has outperformed three of its peer-competitors, but not the giant Rabobank.

The evidence presented in this section suggests that all three banks have achieved superior social impact, while in general out-performing their peers according to long run value creation measures.

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None can question the superior financial performance of these banks and few would question their positive social impact in their respective market places. Many, especially those from a conventional business perspective, might question at whose cost this impact has been achieved; and more generally, how the tension between social impact and financial performance has been managed over time.

:KRSD\VIRUVRFLDOLPSDFW" The preceding section has shown little evidence that shareholders in any of the three banks are paying a price for their developmental mission; on the contrary, they appear to be enjoying premium returns in two of the two banks, at least in recent years. And in the third, shareholders are comfortable in that their target level of return has been achieved.

18 At the level of ShoreBank Corporation, returns from the core bank shown in Table 2 are explicit ly dilut ed as the result of other market development activities to a group ret urn of 7.9%. Note t hat for Triodos, geographic expansion takes place t hrough t he establishment of new branches, t he cost of which is born by t he bank; whereas for ShoreBank, it has been largely carried by t he holding company.

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However, the cost of first pursuing broader social impact may be borne by other stakeholders, such as: œ Staff, who may be paid less than they could be elsewhere; œ Borrowers, who may pay higher rates than they would elsewhere; œ Depositors, through accepting lower interest rates on deposits.

Table 3 below reflects the policies and outcomes of these banks which have determined the distribution of the cost of social impact.

7DEOH'LYLGLQJWKHFRVWVDQGEHQHILWV Stakeholder group Plantersbank ShoreBank Triodos Shareholders: ROE exceeded peers ROE (core bank) ROE was less than 1999-2004 exceeded peers 1999- peers but in line with 2004 declared target Total return to 7.5% 1.32% (Group) 1.04% shareholders p.a. (1972-2004 (1973-2004 (1982-2004 (real) cumulative: 1087%) cumulative: 51%) cumulative: 29.6%) Employee Competitive but not Salaries benchmarked Benchmarked to compensation top of market at 75% percentile for market at lower and senior managers and mid levels; at 50% for all other deliberately lower employees than market for top levels Borrowers: Higher than market by Higher than general Higher than market— Interest rates on 100-200 points— SME market in rehab niche SME niche niche and at market for all lending other products Depositors: Market competitive Market competitive Market competitive Interest rates on deposits

The table above shows that in all cases, depositors do not receive lower rates for the social benefit which their deposits may bring when lent out.

Furthermore, in general, staff do not pay either, since most staff salaries are marked to market. However, Triodos intentionally pays lower than market salaries at senior management levels. This follows from the belief that the extrinsic rewards of the job are highest at these levels; and that paying lower salaries here is both an important signal to the rest of the organization as well as a good screen for the real motivation of top managers.

Borrowing clients appear to pay in part through slightly higher interest rates on their loans, but this is more apparent than real. For one thing, market comparison rates are generic, whereas each institution tends to have specialized niches (such as housing rehabilitation for ShoreBank or smaller SME clients for Plantersbank) in which the comparable rates may well be higher than the average. Certainly, in each case, there are competitors who could lure borrowers if these banks became uncompetitive in their overall pricing. The growing

17 Draft 2.1 balance sheets of all three entities suggest that borrowers are not defecting, but that these institutions are attracting new loan clients at faster than peer rates.

So, can these strong double bottom line outcomes be obtained with little apparent tradeoff in outcome, or are these institutions simply lucky exceptions? The sheer diversity and length of experience of the three rules out pure luck. The focus of questioning must therefore move to how strong double bottom line performance has been achieved and sustained.

5HDVRQVIRUWKHRXWFRPHV Several underlying factors appear to drive the superior financial returns observed at two of the banks.

An obvious one has already been noted, which applies to ShoreBank in particular: while the superior results stated earlier are for the core ‘Chicago’ bank, they are diluted at a group level to half as a result of other less profitable and developmental activities.19 The original holding company shareholders have in fact accepted a lower return on their investment from the start as reflected in the total returns to shareholders in Table 3. The stellar performance of the core bank has essentially funded innovation through other businesses in the group. This has led to some internal tensions which will be explored further in the next section. A group structure which ring-fences more profitable from less profitable operations is not uncommon however. What is uncommon is that the tension has been maintained over time; and that even the highly profitable operation has also been associated with strong impact in regenerating a distressed neighborhood.

More generally, while the banks have been consistently profitable over their 30 year lives, their rapid growth in recent years has increasingly brought them the benefits of economies of scale. The presence of strong economies of scale in financial intermediation has been long suspected, but was only conclusively demonstrated relatively recently across banking systems.20 There is nothing special about this scale effect, but neither is there anything illegitimate about benefiting from it: after all, their peer groups are either of similar size or larger in some cases. In fact, this factor highlights one of the dilemmas for many double bottom line businesses— how to manage growth so as to reach a competitive scale in the first place.

In addition to increasing scale, there is clear evidence of positive returns from specialization. ShoreBank’s focus in one geographic market— the south side of Chicago— has paid off through its ability to manage better the risks of lending there. As noted before, the home rehabilitation lending niche which it pioneered

19 According to Nowak (2004), 70% of the aggregate earnings of profitable ShoreBank Corporation subsidiaries t hrough the 1990’ s was used to absorb losses of startup entities, affiliates or subsidiaries. 20 For a succinct review of recent findings, see Bossone & Lee (2002).

18 Draft 2.1 is its most profitable single business line. Similarly, Plantersbank has developed internationally recognized expertise in investing and lending to Philippino SMEs. Plantersbank has provided technical assistance to other SME lenders in Asia, and its skills in this area were most recently recognized through the launch in February 2005 of a joint SME private equity fund with international management group Aureos Capital.

Specialization in a core competency is not a new success formula. It does bring additional risks, however, especially for financial intermediaries which usually benefit from greater risk diversification. As the Plantersbank vignette in Box B shows, the banks have wrestled with the trade-offs between specialization and diversification over time, but have stayed mission-focused.

%R[&3ODQWHUEDQNZUHVWOHVZLWKPLVVLRQIRFXV The question of mission-based specialization versus diversification has been an ongoing dilemma for Plantersbank. This has been exacerbated by the volatile economic and political circumstances in the Philippines over the years. For officers and shareholders, this dilemma surfaces in the question of whether to convert to become a general commercial bank. A commercial bank license would enable a broader range of diversified, potential profitable activities to be undertaken, such as foreign exchange and securities trading. In an unstable environment, public preference is for larger, apparently safer commercial banks, and bank regulators appear to confirm this preference. Smaller banks have paid a penalty in terms of higher interest rates to attract deposits.

In 1991, in a particularly trying environment which included natural disasters, Plantersbank found the option of conversion appealing. Jesus Tambunting remembers: “We possessed the necessary skills for a successful commercial banking operation. Most of our officers had trained and worked with leading commercial banks not only in the Philippines but also in other countries. The BSP (central bank) governor, who was our recent visitor, had also suggested that we convert into a commercial bank so that we could be granted more prerogatives and therefore be able to do more for SMEs. We only had to ask, and a commercial banking license would be ours. We admit that we were tempted.”

Plantersbank went through a series of consultative meetings and came to the conclusion that its focus on SMEs would be lost on becoming a commercial bank. This potential mission drift swung the decision: as Tambunting says, “We were convinced that it would be extremely difficult to be a commercial bank and not act like one. Our performance would be judged according to commercial banking norms and standards, and in the race for revenues, we could be forced to give less attention to SMEs in favor of the easier and more lucrative corporate accounts. We therefore stuck to our decision to remain a development bank, firmly committed to SMEs.”

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In 2005, Planterbank remains a development bank focused on serving SMEs.

However, the experience of these banks goes beyond demonstrating specialization alone. Each started at a time when their chosen market was neglected by other private financial institutions. Through their success over time, they have created new markets. This market building role requires taking greater risk early on, and investing more, over a longer time frame, than conventional banking horizons may allow. This is particularly evident in the case of the geographic community in which ShoreBank continues to operate. However, Plantersbank also reports going beyond conventional banking, to facilitating market linkages and providing ongoing advice for SME clients. Triodos has been part of stimulating and supporting the development of alternative energy as a bankable sector in Europe.

Perhaps, the biggest indicator of their success in market creation is that today they have direct competitors. Market building is undoubtedly risky however. The cases of these banks suggest that private entities which persist and succeed may reap significant rewards from their investment— both in financial terms, and in terms of social impact.

0DQDJLQJWKH7HQVLRQV While these cases show that there may be no inherent conflict between ‘people and profits’ in the long run, there certainly are tensions to be managed in the short to medium run: day-to-day decisions in areas such as resource allocation, credit policy and product pricing all affect the balance. While the three banks differ in how they have managed the challenges, they have had at least the following elements in common.

First, their shareholders strongly support their mission focus, and clearly understand what this means for financial returns. As ShoreBank’s Grzywinski notes, referring to the early days21: “Our (original) investors would have to be patient. They would have to tolerate a high degree of risk. They would have to have a strong desire to see a new kind of bank take shape. The money did not pour in… ” For Plantersbank, this understanding is expressed primarily in terms of time horizon: founder and major shareholder Tambunting lists the maintenance of a long term orientation and a developmental perspective as among the reasons for the sustained success of Plantersbank.22 Triodos has adopted explicit long term target returns on equity and managed to deliver these returns.

Each bank has had a stable, long term coalition of shareholders. The number of shareholders has been relatively small, except in the case of Triodos which has some 8500 individual depository receipt holders. However, effective control of

21 Grzywinski 1991:88 22 Speech by Jesus Tambunting, January 2004

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Triodos Bank is vested in a Trust (the Foundation for the Administration of Triodos Bank Shares or SAAT) which owns all the voting shares in the Bank. There is an open question over whether the banks could have achieved these outcomes while being publicly traded. The larger they each become, the more pressure may grow to go public in future.

Second, the original founders have continued to play important roles on the board or as top executives and shareholders in all three banks. This has been important for maintaining the original passion for mission, which is at the heart of each. In the composition of their boards of directors, the banks have also sought to maintain the balance between banking skills and mission-orientation. When potential conflicts between profitability and mission have arisen, they report that board and management have invariably opted for the decision which best serves mission.

Third, maintaining focus has meant managing growth carefully. As mentioned earlier, growth is a double-edged sword for a private development bank: on the one hand, economies of scale boost profitability, and arguably leverage impact, as noted above; however, the need to raise more capital or add staff too quickly can dilute the mission focus of the original shareholders and managers. The need to grow also leads to expansion beyond limited geographic or functional markets in which early success has been achieved. This may dilute core business focus. In recent years, all three banks have been able to manage the tension while growing strongly: all have broken through significant scale thresholds in recent years, doubling or tripling in size over the past ten years. They all have ambitious growth plans going forward. Not all investments have been successful however: ShoreBank has in recent years been through a process of closing down or spinning off some of its unsuccessful subsidiaries and affiliates. However, in preparation for financing this growth through new capital, ShoreBank and Triodos have also raised their target return on equity (for example, from 4% to 7% over the medium term at Triodos as described in Box D).

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Triodos Bank has delivered a total nominal return to shareholders of 3.4% p.a. since inception; or just over 1% p.a. in real terms. During the past fiveyears, Triodos has set 4% as a target return on equity of the bank— just above the rate which institutional investors can earn in Dutch long term government bonds. Triodos has achieved this level on average, although it is less than half that of its approximate peer group of Dutch cooperative banks. Strong growth in assets in recent years, together with further opportunities to grow, have raised the need to be sufficiently capitalized in future. In part to support raising further capital, the board recently lifted the target rate of return to 7% within three to five years. While below the current peer average of 9.2%, this is still a big increase on its current level.

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In the light of its strong social mandate, how did the bank come to decide on this measure to boost financial return? And what tensions might this new target place on the social model?

According to Chief Executive Officer Peter Blom, the decision was made primarily to support growth. ³We are now seeing some of the benefits of scale and scope, and have further opportunities to grow. It therefore seemed appropriate that we be in a position to raise further capital, hence the policy decision to raise targeted return”. The seven percent level was chosen to signal that, while Triodos chooses not to deliver the full ‘market’ return of banking peers, it nonetheless needed to raise its return in the current investment environment above the risk free level of government bonds.

The decision was not without its internal questioners, however. At the 2005 Triodos Annual General Meeting at which the decision was announced and discussed, some existing shareholders questioned whether this decision would negatively impact on its ability to fulfill its social mandate. Blom believes not: while margins on lending in Europe are very thin as the result of competition, he sees growth in profitability coming from in non-lending products such as fund management. Triodos is already a substantial manager of over $800m of off- balance sheet specialized funds (over a third of aggregated group assets), which invest in areas like microfinance and green energy sources. Growth in these funds under management generates fees without straining group capital.

This ongoing balancing and adjusting the mix of financial return and social impact by the board of Triodos illustrates well the continuing fine-tuning which is necessary to sustain the model.

Reflecting on the experiences of growth among its development banking members, the Development Finance Forum (of which ShoreBank Corporation President Mary Houghton is a member) states: “we recognize that our own business growth has been more iterative than linear, defined through interactions with the marketplace of borrowers, investors and local economic and civic actors. But it is these four attributes— pioneering leadership, valuable products, building of sustainability and the legitimizing of (social) networks— that seem to explain our path best” (DFF 2004:14). Most of these attributes are shared with conventional financial institutions, but the Development Finance Forum claims to apply them differently: their social networks, for example, extend from the poorest to national and international institutions; and they consciously seek legitimization from their clients.

Interestingly, there are strong echoes of these banks’ experiences in a HBR article written by Rodman Rockefeller in 1971, close to the time when the banks were started. Based on his experience with investing so as to balance profitability

22 Draft 2.1 with social impact, Rockefeller observed that there were four characteristics of programs which achieved both outcomes: “they served local need; they required innovative approaches; they made sense on economic grounds; and they respected the social norms of the community” (reprinted in 2003:142). He too also pointed out that programs like these “also create the foundation for more affluent and dynamic markets”. These banks show similar characteristics and their record further validates this ‘strong’ double bottom line approach.

Each of these banks has tried various innovations in process and product. Some of these— successful and failed— warrant further detailed case studies of their own. There is to be sure no easy formula to be applied. This paper aims merely to highlight the common patterns which make the underlying paradigm of private development banking worthy of attention.

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These three banks have on average a thirty year track record which makes a compelling case that private development banking is feasible. More generally, in the terms developed in this paper, ‘strong’ double bottom line business is possible. It can even be highly profitable in the long run, although this is not likely to be the norm. These bank examples suggest that the standard dichotomy between businesses that intend to maximize profit and those which do not is not adequate or even helpful in understanding the outcomes.

A track record of success in private development banking to date does not eliminate challenges for the future, even though success has created greater resources to deal with them. For some of the banks, in the next few years, there will be a transition in leadership from original founders, who have nurtured and maintained the mission, to the next generation of leadership. For all of the banks, success brings new issues: raising appropriate capital, as discussed in the preceding section, and broadening the operational base of people and systems to accommodate growing complexity in products and markets. Success has also bred competitors in their core markets, not all or even many of whom share a strong double bottom line approach. Furthermore, while the supply of ethical investment or ‘patient’ capital is growing, so is the competition for its use: more and more firms label themselves as double or triple bottom line. Hence the importance of better impact measurement discussed in Section 4.

Building the resilience to overcoming such challenges is at the heart of private development banking. Compared with state-owned development banks which have a social underpin for their mission, private development banks must remain flexible and entrepreneurial to survive. Unlike their publicly owned counterparts which may crowd out the private sector with their entrenched advantages, private development banks must innovate continually to stay ahead of the competition which comes in part from their success. This self-sustaining push to innovate for

23 Draft 2.1 impact, disciplined by market forces, is a core aspect of the emerging private development banking paradigm.

Finally, how relevant is this paradigm to reaching the billions of the global poor who today lack financial services? The global poor by and large do not live in ready-made formal financial service markets. Consequently, they are less amenable to banking approaches predicated on quick returns from ‘impatient’ capital. Indeed, a ‘get rich quick’ approach by certain consumer lenders has already generated a political and social backlash in developing countries such as Bolivia and South Africa.23 In many cases, creating sustainable retail financial markets will require the active participation of banks with a developmental focus and longer term horizon. ShoreBank Corporation and Triodos Group already manage private equity funds with extensive and growing portfolios of investments in microfinance institutions throughout the world. Together, these entities combined serve close to three million lower income people. With each investment typically comes a board role for the investing bank; and an opportunity to share expertise and experience with emerging financial institutions which seek to follow the double bottom line approach.

Their microfinance interests alone will ensure that these three banks have a place in directly serving the global poor in the 21st Century. However, their more enduring contribution may well turn out to have come through pioneering and demonstrating the paradigm of private development banking to often skeptical investors and regulators.

5()(5(1&(6 Bossone, B & J-K Lee (2002) “In Finance, Size Matters”, ,0):RUNLQJ3DSHU , available at: http://www.imf.org/external/pubs/cat/longres.cfm?sk=15884.0 Christen et al (2004) “Financial Institutions with a Double Bottom Line: Implications for the future of Microfinance”, CGAP 2FFDVLRQDO3DSHU No.8 Clark, C et al (2003) “Double Bottom Line Project Report: Assessing Social Impact in Double Bottom Line Ventures”, available at http://www.riseproject.org/DBL_Methods_Catalog.pdf Crook, C (2005) 7KH*RRG&RPSDQ\, Survey supplement to 7KH(FRQRPLVW, 25 January DeYoung, R & W.C. Hunter (2003) “Deregulation, the Internet and the Competitive Viability of Large Banks and Community Banks”, Ch. 9 in Benton E. Gup, 7KH)XWXUHRI%DQNLQJ, Westport CT: Forum Books Dobbs, R (2005) “Managing Value and Performance”, 0F.LQVH\4XDUWHUO\ 6SHFLDO(GLWLRQ, available from www.mckinseyquarterly.com Dobbs, R & T. Koller (2005) “Measuring long-term performance”, 0F.LQVH\ 4XDUWHUO\6SHFLDO(GLWLRQ, available from www.mckinseyquarterly.com

23 See Rhyne (2002) on Bolivia and Porteous & Hazelhurst (2004) on Sout h Africa.

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Development Finance Forum (2004) &DSLWDO3OXV7KHFKDOOHQJHRIGHYHORSPHQW LQGHYHORSPHQWILQDQFHLQVWLWXWLRQV, available via www.dfforum.com Foster, W & J. Bradach (2005) “Should NonProfits seek Profit?” +DUYDUG %XVLQHVV5HYLHZFebruary 2005, pp92-100 Grzywinski, R (1991) “The New Old Fashioned Banking”, +DUYDUG%XVLQHVV 5HYLHZMay-June No 91306 Nowak, J (2004) “Back to the Future— A Case study of ShoreBank”, written for the Development Finance Forum, available from www.dfforum.com Plantersbank (various years) Annual Report, Available via www.plantersbank.ph Porteous, D & E Hazelhurst (2004) %DQNLQJRQ&KDQJH, Cape Town: Doublestorey Prahalad, CK (2004) 7KH)RUWXQHDWWKH%RWWRPRIWKH3\UDPLG, Philadelphia: Wharton School Publishing Rhyne, E (2001) 0DLQVWUHDPLQJ0LFURILQDQFH, Bloomfield CT: Kumarian Press Rockefeller Foundation & Goldman Sachs Foundation (2003) 6RFLDO,PSDFW $VVHVVPHQW, available via http://www.riseproject.org/reports.htm Rockefeller, R (2003) “Turn Public Problems to Private Account”, August p.129- 136 (reprint) Tambunting, J (2004) “A Journey with the Philippino Entrepreneur”, Speech to MAP Meeting, Manila ShoreBank Corporation (various years) $QQXDOUHSRUW, Available via www.sbk.com Triodos Bank (various years) $QQXDO5HSRUWAvailable via www.triodos.com

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