Shaping the Path in Financial Literacy

American psychologists Chip and Dan Heath presented a framework for behavior change interventions in their 2010 book Switch that includes a rationale for changing the environment or situation in which a problem occurs in order to help solve the problem (“shaping the path”). In the case of pricing transparency, regulators and networks can work to shape the path for clients and MFIs by providing simple, standardized, accessible “buckets” that contain understandable information about how much credit really costs.

MicroFinance Transparency[1] is in the process of developing financial education materials to promote pricing transparency in Rwanda and Malawi.  During the African Microfinance Pricing Transparency Leadership Forum last October 5-7, the role of “shaping the path” in financial literacy initiatives was highlighted. In order for consumers to truly understand the cost of their credit and to make informed decisions, a number of country-wide strategies are necessary.

Luckily, in the case of pricing transparency, MFTransparency has already broken ground on a number of concrete activities that can be put in place by networks and encouraged by regulators. These actions, when administered in conjunction with other interventions that focus on MFIs and clients (such as face-to-face training, radio programs, and print materials), will provide the environmental or situational change necessary to clear out some of the obstacles on consumers’ paths to better, more informed decisions about credit.

Require the use of APR/EIR by lending institutions. This recommendation is likely to be controversial and I expect push-back from MFIs when I state that this is my opinion. However, the needs assessment for the financial education made it absolutely clear that clients currently look at the publicized interest rate (i.e. 2.5% per month, 3.0% per month) in the same way that a credit-card-carrying global northerner looks at his or her APR or EIR. Americans, Canadians and Europeans are given the chance to compare the APR or EIR of different credit card companies, use it as a benchmark for the cost of their credit, and try to choose the lowest rate for which they qualify. If clients are already looking at their interest rates in this way, but erroneously, why not give them a more accurate and trustworthy tool?

Simplify information on loan terms for clients. APR or EIR is part of the simplification process, but clients also need to know all their terms and conditions in order to make good choices for them. A simple tool, such as the document in Figure 1, could be used to communicate loan terms to clients and be given to them as a resource. (This could be used even in the absence of APR or EIR requirements in a country – a good first step towards full transparency.)

Publicize interest rates using APR or EIR. I was impressed with the way that Bank of Zambia is already doing this.  APRs are published in newspapers accompanied by examples to help clients compare the costs of loans at different institutions. By putting this information in a public place and making it accessible to borrowers and potential borrowers, the Bank of Zambia is making it possible for Zambians to make more informed decisions and is helping to shape the path.

Educate clients about where to find information on credit and how to interpret it. Using APR or EIR (or a comparative convention) could potentially be a great confusion to clients, if they are not educated prior to and during a change in how interest rates are published. Going from a world in which they are used to seeing “2.5%” and “3.5%” as publicized interest rates to a world in which they see “35%” or “50%” would require a campaign to help them understand that nothing is changing except the way in which the costs are communicated to them. Our needs assessment showed that clients, while they do not fully understand interest or total cost currently, still pay attention to and are sensitive to a rise in interest rates.

Some caveats to keep in mind

• Change at the national level takes time. MFTransparency is developing financial education materials that can be adapted if and when a regulator wants to make the move towards more transparency, whether that is in the near or more distant future.
• Cost is not always the most important consideration for borrowers. When we publicize and educate on interest rates, we expect some borrowers to make different decisions. However, our needs assessment made clear that sometimes the repayment period, repayment schedule, or wait time for the loan trump cost for borrowers. The important thing is to give borrowers the necessary information to be able to make informed and beneficial financial decisions for their own households.
• There is likely to be push-back from financial institutions. As Dr. David Baguma noted during the African Microfinance Pricing Transparency Leadership Forum, “Suppliers (of credit) don’t want to talk about transparency – they cannot take the lead. They will never want to be transparent. The indirect benefits of not being transparent are too strong.” In the short-term, convincing any but the most socially-minded financial institutions to use the MFTransparency package may be difficult. This makes sense. What supplier will want to teach clients to go to a cheaper lender? However, as Dr. Baguma noted, eventually financial institutions may find that “an informed client is a loyal client,” and in the long-term transparency is beneficial to the suppliers and the entire industry.

MFTransparency will pilot its financial education program in Malawi and Rwanda in January and February of 2012, putting some of the assumptions above to the test. Hopefully, it  will be able to find the right size of “bucket” for credit clients.

by Jessica Massie

[1] MicroFinance Transparency is working in partnership with 17Triggers, a Behavior Change Lab that specializes in innovative behavior change interventions.