Responsible microfinance: Regulators agree on the fundamental questions to be answered
A few weeks ago I was lucky enough to participate in the African Microfinance Pricing Transparency Leadership Forum in Nairobi, Kenya hosted by MicroFinance Transparency. This forum brought together policymakers, regulators, consumer advocacy associations, networks and industry actors from over 20 African countries. It was a three day-event that brought to light many of the issues surrounding pricing in microfinance, disclosure issues and the way forward if we are to achieve satisfactory levels of responsible practice in the microfinance industry.
Of particular interest in the discussions at the forum were the fundamental questions that all different stakeholders will have to address so as to achieve what most delegates called “acceptable levels of responsible finance”. During one of the lunch breaks I shared with representatives from Zambia, Ethiopia and Liberia, there was agreement that transparency is a pre-condition for responsible pricing/finance because it enables clients to understand and compare products and providers. However, for institutional players in the microfinance sector to become more responsible in their practices, two fundamental questions have to be asked and answered: How? and Why?
Speaking to the “how” question, one participant called it “doing well while doing good”, to mean that microfinance services providers should price their products and services in a way that contributes to the long-term financial health of their clients while meeting their own needs for financial sustainability. I listened to stories and experiences from different countries that generally confirmed that the microfinance service delivery mechanisms have been changing in almost all regions over time, from money lenders to subsidized credit and later to greater emphasis on the double bottom line approach.
However, discussions among the policymakers especially pointed to the fact that now, more than ever, there is greater institutional tendency to a single bottom line approach. In other words, the tendency towards the temptation of institutions wanting to maximize profit by charging high prices on their products and services. Even if considering only the financial bottom line, regulators agreed that policy should encourage service providers to strive to achieve efficiencies that allow prices to be as affordable as possible while delivering high quality products to clients.
Is the microfinance industry experiencing widespread mission drift? As one participant rightly put it, financial service providers have a responsibility to take into consideration the client’s ability to pay while also examining their operational efficiency and profit levels. Microfinance is a rare industry with nearly 100% of clients at the bottom of the income distribution pyramid and therefore careful attention is required. But why should financial institutions be responsible in their practices? The quickest answer would be why should they not be? It is part of the social mission of most institutions, and when working with the poor there is an important imbalance of power to keep in mind. The temptation of large profits can lead some to irresponsible practice and irresponsible practice leads to client abuse, not to mention unsustainable markets.
Policy is an important tool for managing this balance. Through the Forum, different regulators shared the policies they have in place for facilitating responsible practice. For example, the Zambia delegation discussed their Banking and Financial Services (Cost of Borrowing) Regulations, issued in 1996, which provide a regulatory framework aimed at promoting transparency in the pricing of loan products and protecting the public from exploitation by lenders who might use obscure loan pricing practices. This regulation requires lenders to disclose the cost of borrowing to the client, at or before the time at which a loan is made. This disclosure largely takes two forms. The first is a written statement (specific loan terms and conditions) to the customer and/or a notice displayed in each of the lender’s branches (stating general loan terms and conditions). The cost of borrowing regulation also requires the lender to disclose the manner of calculating the cost of borrowing and expressing it as an effective annual percentage rate. It was also interesting to note that apart from requiring lenders to disclose the cost of borrowing to borrowers, the Bank of Zambia has been publishing the comparative cost of borrowing in newspapers of general circulation in Zambia. I was grateful that the Zambia representatives shared their experience in implementing this policy, as it provided substance for discussion with other country delegations, in comparing their own experiences and suggesting alternatives or ways that this policy could be expanded even further.
Like in Zambia, all regulators of African microfinance markets should commit to building strong and transparent microfinance markets. More mature markets are taking a bold look at how to restructure policies to encourage responsible finance. In the context of the African markets, the obligation of stakeholders inside microfinance should be to self-regulate the industry and promote responsible practice. In addition, the regulators should play a big role in setting up and implementing formal regulations that helps maintain the balance of power between institutions and their clients. This will protect the poor and the industry as a whole.
One of the most resounding themes I heard at the African Microfinance Pricing Transparency Leadership Forum was the concept that responsible finance will call for wider collaboration among consumers of credit, microfinance institutions, funders, donors and the policymakers and regulators. Let’s start with the education of all stakeholders, especially the MFIs and the regulators. This should be coupled with financial education programs for the consumers of credit. Efforts to educate and facilitate discussion will create an enabling environment for a healthy microfinance industry. So as to distinguish responsible practice from ordinary practice, we will need to develop excellent codes of conduct for providers of credit, elicit outright commitments to transparent pricing and put in place standards to ensure a consistent double bottom line approach to measuring social performance. All stakeholders in the industry, from regulators to MFTransparency ourselves, have a role to play in this process.