Colombia is Moving Toward Pricing Transparency, But Can Still Improve
This post was originally published on the Center for Financial Inclusion Blog.
Policymakers in Colombia have been cautiously moving toward a transparency-based approach to pricing for microfinance, reducing their traditional reliance on interest rate caps. Important legislation in 2009 and 2010 appears to be having a positive effect, as Asobancaria, the Colombian Banking Association, asserts in a recent article. Asobancaria notes that since the changes, the number of microcredit loans offered continues to increase.
We at MFTransparency are also pleased with the initial results. We urge the government to focus on simple, straight-forward regulation to ensure that financial service providers understand and apply the law in a clear and consistent manner.
Progress Toward Transparency
The Colombian government took steps to consolidate and enhance consumer protection and pricing transparency in the commercial and microfinance sectors through Law 1328 of 2009. This law sets out strict regulations regarding the minimum information to be provided to prospective borrowers, the prohibition of abusive clauses, and an effective mechanism to deal with complaints. It also provides sanctions for abusive practices.
More boldly, President Santos’ government unfroze the microcredit usury rate as of September 2010. We are pleased that this more liberal policy appears to be having the desired result: more small loans without an excessively pronounced increase in prices. For several years, the Colombian microfinance sector has operated with price ceilings set in relation to the current banking interest rate for ordinary credit transactions, known in Colombia as the TIBC, which reflects the average rate that the banks charge on credit transactions. On paper, the system is simple enough: Usury rates for consumption and microfinance loans are fixed at one and a half times the TIBC.
The Superintendency currently has two categories of interest rate caps: those for conventional loans and those for microfinance loans. Supervised institutions must report their rates by category on a weekly basis. These statistics are used by the SFC in order to modify the consumer loan rate quarterly and the microfinance rate annually (it currently stands at 44%/year).
Opportunities for Increased Disclosure
Nevertheless, MFTransparency still sees room for improvement:
- Industry-wide application. Firstly, we are concerned that the scope of the new transparency measures remains restricted to the regulated sector. This is an ongoing challenge around the world: Only regulated institutions fall under the policy framework; however, many microfinance providers are not regulated. Although in Colombia the majority of the microfinance market is represented by regulated institutions, numerous providers, including some serving the most vulnerable clients, are not covered.
- Inclusive official pricing formula. Secondly, we think that now is the perfect time to revisit the national formula used to calculate the Effective Interest Rate (EIR). This rate is used as a rate of reference in usury legislation, and lenders are required by law to communicate it to the borrower. The current definition excludes both compulsory savings and, for cooperatives, loan-linked member contributions. Such features significantly affect the true price of a loan. The formula will only be effective as a comparative, transparent tool when fees, commissions, and other charges are fully incorporated.
- Disclosure of additional charges. Finally, Mipyme Commissions can considerably impair the ability of borrowers to assess the prices of microcredit loans. These charges, applicable to loans up to 25 times the minimum salary, are not included in reported EIR (in part because they were passed prior to the existence of a separate usury cap for microcredit loans). Nor were they to be taken into account when considering the legal price limits. Although they are not generally included in the rate, Colombian transparency legislation does require the amount to be clearly disclosed to the client. Mipyme Commissions can be confusing and misleading to some clients who may have low financial literacy rates.
These three items, taken together, represent a significant remaining obstruction to pricing transparency. In addition, MFTransparency would also recommend consideration of standardized loan documentation. With this, even if a borrower does not fully understand all the terms of the loan, he knows which information is where and can easily compare products. This could be relatively easily implemented and would result in a substantial increase in borrowers’ abilities to make decisions based on simple and clear information.
Seeking the Ultimate in Transparency
Transparency in microfinance requires simplicity, which is hard to achieve in a complex regulatory environment. Regulators should strive toward a single number allowing clients to immediately and confidently understand that X lender offers lower prices than Y. A common rate, applicable to the entire industry and presented so that clients can evaluate the true cost of a loan, would create the transparency required for a fully functional and competitive microfinance industry in Colombia.
by Alexandra Fiorillo