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