> Posted by Robin Ratcliffe
I’m in Nairobi, Kenya, this week attending the Africa-Middle East Regional Microcredit Summit. Wednesday I participated as a panelist in a session entitled “Transparency in Interest Rate Pricing and Other Efforts Towards Consumer Protection” along with MF Transparency’s Chuck Waterfield, Fabian Kasi, CEO of Finca Uganda, and Bilha Maina from the World Bank’s Financial Sector Deepening team in Kenya.
What struck me most during the session is how over the last year we have experienced a growing consensus around the core Client Protection Principles now endorsed by close to 1,000 organizations and MF professionals in 99 countries. It is clear that central banks, advocates for financial inclusion, microfinance investors, and MFIs themselves recognize that our clients deserve – and want – information on the cost of financial services offered displayed in a way in which they can easily compare options.
The question in my mind, however, is just how do microfinance clients prefer to receive that information?
After eight years heading Finca Uganda, Fabian Kasi declared that rather than an interest rate, their clients definitely want to know the total cost of their loan, with all fees or other commissions wrapped into a single price. If a client is borrowing 1,000 (of whatever currency) for six months, Fabian says they want to know the amount of their monthly payment and the total cost of the loan. Transparent pricing is not enough, however. The loan documentation should be in language understandable to clients; it should be read to them if they are illiterate. And, clients and MFIs both benefit from borrowers’ understanding the overall risk and responsibility of their taking on a loan.
We still have a lot to learn. The Smart Campaign is slated to conduct client research later this year to learn more about which principles are the most important to clients and how they best receive information. I’m happy to our readers’ thoughts on this, too.
Facebook
Twitter
2 comments
Comments feed for this article
April 10, 2010 at 2:16 am
Chuck Waterfield
I also was impressed with the high turnout and very active participation in this session on Pricing Transparency and Client Protection here in Nairobi. These are exceedingly important topics for the industry. We are advancing in our understanding of the issues and in discerning how to improve our practice.
These are not easy topics, but we are advancing. I do see increasing intent and desire, but we also need to learn what works and why. In the area of transparent pricing, we often see MFIs such as FINCA Uganda making an effort to try and communicate the true price via supposedly concrete “total cost” rather than abstract “interest rate percentages”. In deeper analysis we see that while seemingly clear, intuitive, and transparency, “total cost”is not an appropriate solution. One of Fabian’s comments during his presentation pointed out this limitation. FINCA Uganda finds that if a client is choosing between two loans, each of 1,000 shillings for 4 months, then the client can compare total cost. But if one loan is 1,000 shillings for 4 months and the other loan is 1,000 shillings for 6 months (or the second loan is 1,400 shillings for 19 weeks!) then the total cost of borrowing approach breaks down. He told us how clients got confused. We would be confused as well.
In other words, total cost only works when comparing two products that are exactly the same. Why does truth-in-lending legislation around the world use APR (Annual Percentage Rate) and EIR (Effective Interest Rate) rather than total cost of borrowing? Because it allows the consumer to see the cost of RENTING a unit of money for a determined amount of time. Borrowing money is renting money. Consumers rent variable amounts of money for varying lengths of time, and any business school textbook in the world will tell you that the Internal Rate of Return (IRR) is the only way to determine the true cost. IRR is what is used to calculate APR and EIR.
I am not saying that the only way for us to tell clients the true price is to use abstract interest rates or teach them IRR calculations. There are other means of conveying this information, and we at MFTransparency are working with a group in the industry to develop these equivalent measures. My word of caution here is not to go down the path of assuming that if we have communicated ‘total cost” to the borrower that we have then given the client the necessary information to make an informed decision. We will soon have more details and materials available to better understand these issues at http://www.mftransparency.org.
We are advancing in our understanding and practice of transparency and consumer protection, but we need to continue deepening our understanding of the issues and determination of appropriate practices.
Chuck Waterfield
CEO & President
MFTransparency
April 24, 2010 at 8:50 am
Alex Counts
The Nairobi conference was an important milestone for the Microcredit Summit Campaign, the Smart Campaign and African microfinance. Your post, Robin, points to some important issues that are often misunderstood with regard to price transparency. First, I agree with you that interest rates in isolation are an incomplete way of looking at pricing. I am glad the Smart Campaign is grappling with this, notwithstanding Chuck’s cautions above. Second, I have long believed that microfinance clients (despite their lack of formal education) often understand more about their loan contracts than small business owners or consumers who are involved in borrowing in industrialized countries. This should not absolve us from making it even easier for clients in developing countries to understand more so they can compare products and make informed choices.