How do we determine a “transparent price”?

Borrowers are often charged a complicated combination of interest and fees. The Annual Percentage Rate (APR) is the means used in the US to combine all of the costs the client pays and convert it into simple, declining balance interest rate. This allows stakeholders to easily compare the prices of different loan products.

Outside of the US, the more common means to calculate transparent prices is the Effective Interest Rate (EIR). APR and EIR share the core approach of determining the interest rate for the payment frequency — say a month, or a week — but differ in the way they convert that monthly interest rate into an annualized rate.

For a monthly interest rate of 1%, the APR does a simple conversion by multiplying by 12, giving 12%. The EIR is more precise in financial terms, taking into consideration the affects of compounding. For an interest rate of 1% per month, the EIR gives an annual rate of 12.7%. The EIR is the European Union standard and is also used in a large number of countries around the world.

How we collected the data

MFTransparency collects data country-by-country. In each country where we facilitate the transition to transparent pricing, we follow a systematic process, and our process in BiH provides a good example for understanding our procedure.

The MFTransparency team visited Bosnia and Herzegovina in April 2009 to conduct training and data collection for the Transparent Pricing Initiative. Thirty-two people, representing fifteen financial institutions and five industry bodies participated in a full-day workshop that addressed the importance of pricing transparency, the need for standardized and transparent reporting of APRs and/or EIRs, instruction on the MFT data collection tool, and training on how to correctly and appropriately calculate APR and EIR.

In the following days, MFTransparency met individually with many financial institutions to assist with the data collection process. Within two weeks of the workshop, nearly all the MFIs had submitted completed data tools together with electronic copies of sample repayment schedules. The remaining data came in the following weeks resulting in 100% of the AMFI network membership participating in the study.

Once data was complete, the MFT team reviewed, verified, and did statistical cross-checking of the data. If any data seemed inconsistent or if MFTransparency noticed potential mistakes in the data, we sent requests for clarification to the financial institution.

Prior to publication, we shared the completed and verified data with each individual MFI for final approval, asking them to review the data, check for any possible errors, make comments on the initial findings and/or suggest revisions or changes.