> Posted by Sergio Guzmán, Lead Specialist, The Smart Campaign, CFI
The Smart Campaign will soon launch its Certification Program on client protection for microfinance institutions (MFIs). In this second post in a series, Sergio Guzmán uses his experience from the field to shed light on standards that are often overlooked by MFI managers but that are a crucial part of client protection.
When I talk with microfinance practitioners about interest rates they often say, “Clients don’t care about the interest rate; they care about the installment amount and how quickly you can disburse the loan.” Also, I’ve often heard from providers the following gem: “The most expensive loan is the one you never take out.”
In my experience, it’s absolutely true that clients are very concerned with how expensive loans are going to be relative to their monthly income, and it’s also true that when seeking a loan, clients want the money now if not sooner. But providers should not let those client traits become an excuse for non-transparency in price structure and calculations.
Let me explain:
In many countries with Annual Percentage Rate (APR) regulations , I have seen providers present clients with a monthly nominal rate. “So that clients understand better,” they say. This of course is sometimes a marketing ploy, since 3 percent a month might seem cheaper than 36 percent a year. However, if all costs have been incorporated into that 3 percent figure, it does not violate acceptable practice.
What does violate standards is when providers confuse clients about total costs by charging fees and then stating a monthly charge that omits them; that is to say, instead of the above 3 percent monthly interest rate, a provider advertises a 2.5 percent monthly rate, not mentioning additional fees (credit bureau check, insurance, disbursement fee, administrative fee, paper fee, among others) that would have to be counted in calculating a fully transparent APR. The argument that these fees are not included in the advertised interest rate because they are not strictly interest charges is a half-truth at best, and designed to obscure the facts from clients. Chuck Waterfield illustrates this superbly in his webinar: Understanding the Price Curve in Microfinance.
The Smart Campaign standards require interest rates to be presented in a manner that avoids confusing clients about the total costs of the loan. The presentation of pricing should also include a format that would in theory allow a client to make a direct comparison to competitors. APR, when calculated to incorporate all fees effectively capture additional costs charged by providers and aggregate them to an understandable annual fee that can be compared across providers.
Providers should move away from using fees as a way to reduce the stated interest rate. Let’s say it straight: tactics like this aim to trick the client. After all, if providers try so hard to make their prices look cheaper, doesn’t that suggest that clients ARE price sensitive and they DO care about interest rates?
Image Credit: PBS
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