> Posted by Juan Carlos Izaguirre, Financial Sector Specialist, World Bank
In preparation for the launch of its Certification Program, the Smart Campaign’s Straight Talk blog series highlights standards that may be overlooked by microfinance institutions but that are an important part of client protection. This sixth post in the series by guest blogger Juan Carlos Izaguirre highlights a very specific practice at the heart of the client protection principle on transparency—and essential for certification: client contracts.
Can you imagine renting an apartment, an office, or a farm, based on a purely verbal agreement? Centuries ago codes of honor and verbal agreements may have been the norm, but not anymore. People want to avoid misunderstandings and forgetfulness by having written contract agreements, especially for long-term transactions. Now, can you imagine signing a rental agreement but then not receiving a copy of that agreement? In practice, not having a copy is almost like trusting in a verbal agreement. To be honest, I would not feel comfortable signing a document without receiving a copy. I would be suspicious of that transaction. Why would the owner not want me to have a copy of the contract? What is there to hide? I have a sense that you would feel similarly uneasy.
If this is well understood in rentals, then why does the financial industry not follow suit? In more than five years working in different countries across the globe, I keep discovering that many financial institutions do not give a copy of the financial contract to their customers. I have heard several reasons/excuses for this behavior: “The client would not like me to charge him/her for an extra copy of the contract.” “The lawyer charges a lot for a signature, so we cannot afford another copy.” Perhaps, but if there is not enough money to afford paper sheets and ink cartridges, then I would be afraid of the financial situation of the institution!
Other institutions say that “clients do not care about the full contract, they only ask for the payment schedule,” or “clients will not understand the contract, they just need the payment schedule.” Maybe clients are not aware that they can have a contract, maybe they have never seen one in their lifetime, or maybe they don’t think they will need the contract later. However, consumers really do need the full contract terms and conditions, as a matter of principle. Contracts contain the legal basis of a transaction and as such consumers have the right to receive a copy.
Contracts are like the user’s manuals for financial products. They contain detailed information that may not seem quite useful when the financial product is acquired, but will become useful when questions arise. Now that many of us are in the pre-Christmas shopping mood, can you imagine buying a new TV and not receiving any type of manual? Surely there are several paragraphs in that manual that have technical information and are not easy to understand, but there is also information that can be quite handy when we have a problem—and we can check the manual first before calling a store or manufacturer.
Contracts are a symbol of transparency, a mechanism to instill trust and reduce fears, especially with clients that are not savvy on financial transactions. Having a copy of the contract would also contribute to the efficiency of the system. If clients have any doubt about their financial product or service, they can first read the contract on their own or with the help of friends, relatives, or community leaders. If clients have a problem, their dialogue with an MFI officer would be easier if they have read the contract, which might in turn reduce the time spent to solve problems.
It is true that contracts are often hard to understand. It is a great idea to work toward more streamlined and simple documents. It is also a good idea to provide a “key facts” statement that summarizes the contract terms and conditions. That step has been implemented in other countries. However, the contract is the basis of a financial transaction, so however difficult it may be, the client still needs to have it.
Sharing a copy of the contract with the consumer should be a basic, obvious, common practice for financial institutions, which would help them to build a more trustful and transparent relation with their customers. There is nothing more valuable in business than earning the trust and loyalty of a client. Regulators should not even have to intervene to make it a requirement – it should be common sense! And, for sure, clients should not have to ask Santa for copies of their contracts this Christmas.
Juan Carlos Izaguirre works as a Financial Sector Specialist with the World Bank’s Global Program on Consumer Protection and Financial Literacy.
Image Credit: Villages Connected
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December 7, 2012 at 4:02 am
Anand Naik
Dear Juan,
I do agree with you that the clients should have the copies of contract/ agreement that they enter with financers. It should be self goverance rather than regulation. To extend it further, all receivables,charges and rates should be part of such agreements. The terms and conditions should also be clearly spelt out for have more transparancy.
In India, this practice is followed, but as most of the finance companies observe that these contracts are hardly read by the customers. However, the customers are explained briefly about the contract in a language that the customer understands before signing the contract.
As part of financial literacy, the above point and the deatils of contract are explained to the customers.
What I feel that inspite of such initiatives, the customer psyche, is yet lagging on account of need for credit. This leads to Over indebtedness at the individual level, as the customers are not in a position to manage their finances correctly or they go for multiple lending to meet their consumptive needs.
Anand
December 7, 2012 at 9:11 am
John Gitau
Juan Carlos,
I like your polite approach to Financial services contracts and the clients entitlement to them. I would look at contracts from three dimensions: The content, context and Intent. The content is about terms of the service. The context is the provision of the service and the acquisition of the same by the customer, where “he who pays the piper calls the tune”. And the intent is to spell the terms in a way that safeguards more the interests of the service provider. The relationship as spelt out in the agreement is never symmetrical. The one who designs a product is always miles ahead of the intended beneficiary in terms of the morphological structure, benefit dynamics and sophistry of the underlying. And the purpose of a product or service is to benefit the designer in terms of income and protection from the risk in the course of product delivery or sale. Why would a financial institution design products or rules that are against their very business? Even if regulators come in with rules, the providers will always get round them.
Therefore, the power is not in the customer walking away with the agreement or contractual papers. The power is in the endowment of customers with financial capability. That way, as financial institutions use their skills to craft financial products, the customers will use their financial literacy and capability skills to evaluate the products, accept those in line with their needs and reject those which are exploitative or with hidden agenda. So, customers should be able to smoke out the pseudo benefits, flash out deception in the small print and have the guts to shout “thief” when they unearth a hidden trickery in interest computation or unwarranted fees and levies. There is one blatant and haughty statement that always pervades financial services agreements such as mortgages and loans that goes “the bank has the right to adjust the interest rate without reference to you”. The same hardly appears in fixed deposit agreements. Financial capability will give customers the confidence to walk into any financial institution however intimidating the queues or banking halls are and be able to look the bank manager in the eye and ask any question without feeling intimated by the immaculate suit and tie.
Financial services provider always ensure the products documents are long, in small print and unnecessarily elaborate as if the customer is buying the entire bank in the case of a loan, deliberately to dissuade intensive reading. The signing time is usually the most rushed with excuse from officers that there are more customers to serve.
Who will provide financial capability to the consumers? Not the financial institutions themselves of course. Some financial institutions concort financial education departments which end up being facades.
Financial capability needs to be delivered by independent institutions set up for that purpose. Governments should be able to support such institutions so that they provide financial capability to everybody without bias. That is what we at Kenya Financial Education Centre (www.financialeducationcentre.co.ke) do. And do you think we are so popular among financial institutions? You guessed right.
December 10, 2012 at 4:47 pm
Juan Carlos
Dear Anand and John,
Thanks for your very valuable comments and insights from your country experiences. They bring to the table other important client protection issues related to the handling of contracts. My post aimed to shed light on the importance of a fundamental right that is many times forgotten: the customer’s right to receive a copy of the contract.
Once that basic right is fulfilled, I agree that it is essential to ensure that customers are able to understand the key terms and conditions of the contract. As you mentioned, providing consumers with financial education is very important. A financially capable consumer would be more confident to ask questions to the officer at a financial institution, and demand more information. However, it is good to keep in mind that financial education is not sufficient.
Unfortunately there are many recent examples of countries where financially capable consumers failed to make sound personal finance decisions. A capable person may still have a hard time to fully understand the conditions of a 20-page contract written in small font size that has to be read in few minutes. This is why, in addition to financial education, financial regulators and industry associations are implementing different types of “consumer disclosure” measures to help customers in their efforts to understand financial products. For example, by developing “key facts statements” or “summary sheets” that summarize in one or 2 pages the key terms and conditions of a contract agreement.
The World Bank’s Good Practices for Financial Consumer Protection identifies 4 key areas: business practices, consumer disclosure, complaints handling and financial education. In the end, all these areas complement each other and should be tackled when trying to develop an effective client protection strategy.
December 13, 2012 at 9:12 am
John Gitau
Thanks Juan. You have articulated the issues very clearly in your response and I can see the importance of the other three pillars in your last paragraph.