Pricing Transparency in the Indian Microfinance Industry
by Nithya Sridharan
For most people, truly understanding the fine print on their loan contract can be a daunting task. Even for people with the advantage of higher education; discounting cashflows across different time periods and transfiguring between various forms of expressing interest rates is not easy. Now imagine yourself in the shoes of India’s 24 million microfinance customers, who do not have the advantage of elementary education, let alone higher education. This huge client base must now cope with the copious amounts of complex pricing data of microfinance products and must be able to discern which product is most suitable for them. This leaves them vulnerable to dubious MFIs and loan sharks. Protecting and empowering them is the mark of a responsible industry and the key to achieving this is transparency in pricing. Clear, sufficient and timely information about credit products and their pricing, enabling MFI clients to make informed decisions is the aim of pricing transparency.
Before delving into the details of what has transpired in India to address the issue of pricing transparency, it is relevant to understand what contributed to the pricing melange in the first place. Around the world, there has been a lack of transparency with respect to the true prices of loans in microfinance. One reason for this may be that microloans have a higher price than standard loans due to the comparatively higher cost to the MFI of servicing those loans.. The Annual Percentage Rate (APR), a standard way to represent the true price of the loan paid by the borrower in annualized terms, comes out substantially higher in the microfinance industry vis-a-vis conventional banking prices. To the common person, that sounds outrageous as they do not quite understand the dynamics of the business and see a final figure which sounds unacceptable to them. So many MFIs simply stopped expressing the true price of the loan using APRs. They began to use quoted prices which were seemingly lower than the true prices. Once MFIs began adopting this route, it became hard for anybody in the industry to actually quote the true price. To do so would leave that MFI at a great disadvantage of advertising a really high interest rate; though the MFI in reality could have the lowest true price in the market. Before one knew it, hidden costs, compulsory deposit taking, insurance charges, and a lot of mumbo jumbo confusing the clientele were making the rounds, leading to obfuscated prices and a deviation from pricing transparency. Clearly the problem needed to be addressed both on a global level as well on regional and country-specific national levels.
On the global industry-wide level, this is precisely why MicroFinance Transparency (MFTransparency) was established five years ago, to be the venue for the microfinance industry to publicly demonstrate its commitment to pricing transparency, integrity and poverty alleviation. On the national level, and with the particular case of India, the industry and the central bank, (the Reserve Bank of India -RBI) had to pool in their efforts to tackle many issues that were plaguing the microfinance industry, including that of transparent pricing. The RBI’s guidelines on Fair Practices Code (FPC) for Non-Banking Financial Companies (NBFC) outline a number of key transparency principles to equip microfinance clients with information to make informed decisions. It is mandatory for NBFC-MFIs to comply with the RBI directives in India. Under the directive, it is required that the FPC is displayed in the vernacular by the NBFC-MFI in its offices and branch premises. It is also required that the pricing of loans should involve only three components – the interest charge, the processing charge, and the insurance premium and that this should all be clearly reflected in the loan agreement. The fact that no penalty can be charged on delayed payments and that no compulsory security deposit or margins are to be collected from the borrower must be made clear to the borrower according to the RBI. The framework further supports client protection in matters of transparency by including guidelines on client education through training. It states that the training about loan products, if any, should be offered free-of-charge to borrowers and that the field staff should be trained to offer such training.
“The market is way more mature today than it was three years ago” says N Srinivasan, independent director of Equitas and a board member of MFTransparency referring to the current state of the microfinance market in India. “Today, in accordance with the RBI guidelines, one has to provide information about the product in the form of a loan card or a pass book or other forms specified. It is also required to use the local language and communicate in a way that is easily understood by the clients.” The RBI guidelines further state that the MFIs must, at the very minimum, communicate the rate of interest on a declining balance scheme, processing fee, other charges, total charges recovered for insurance, and risks covered. The MFIs are also required to communicate the interest rates as an all-inclusive fee or full APR and as the equivalent monthly rate as well.
There have been several initiatives from the industry and service providers to address the issue of pricing transparency in India as well. MFTransparency conducted a Transparent Pricing Initiative in India in April 2010 for the first time. A series of workshops were conducted in the country, which were attended by various stakeholders in the industry. The Initiative aimed at raising awareness on pricing transparency through a combination of activities including data collection, training, and the development of education materials. MFTransparency promotes transparent pricing by presenting pricing information on credit products in a clear and consistent fashion, not just from India but from across the globe. The Microfinance Institutions Network (MFIN), an association of NBFC-MFIs, and Sa-Dhan, an association of community development finance institutions, are two associations in India that have detailed out a Unified Code of Conduct (UCOC) to be followed by their member MFIs. The UCOC adds on to the mandatory RBI requirements, strengthening the principle of transparency in pricing. Some principles of the UCOC include the periodic checking of client awareness about products and services offered, clear conveyance of insurance terms to the client, and disclosure of financial statements of the MFI by qualified auditors. There are many other independent organizations and initiatives that are also trying to aid MFIs in overcoming the shortcomings in pricing transparency on both national and global levels.
Overall, pricing transparency is seen as an important part of client protection in India by the regulators as well as the industry. The RBI framework and UCOC initiative by the industry advocate clear communication to the clients as a means of protecting the client from financial gobble-de-gook. Whilst tremendous progress has been achieved in this area, there is a lot of room for improvement. “Like in any industry, there are bound to be outliers. Pricing transparency is not adhered to by one and all, “says Mr. Srinivasan commenting on the issue. A periodic assessment of the level of compliance of MFIs with the UCOC pricing transparency principles will help identify the areas of deviation, making it easier to point-out the dubious MFIs.
MFTransparency, in partnership with MFIN, is currently recollecting transparent pricing data in India. In the coming weeks the true prices currently paid by Indian microloan borrowers will be publically disclosed. This disclosure will provide a valuable insight into the impact of the various pricing transparency efforts within the industry, and ultimately will help microentrepeneurs to make better informed decisions about their loans.
 Data from MFIN’s MicroMeter report in March 2013
Nithya Sridharan holds an MSc in Financial Engineering from Imperial College London and has a passion for in-depth financial journalism and developmental economics. She has worked in the financial services industry in London and in India. Nithya is currently an independent researcher and writer in finance. Her writings have been published extensively in various publications across the globe.