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From Opaque, to Transparent, to Responsible Practice

on April 29 | in Blog | by | with 1 Comment

by Chuck Waterfield, CEO of MicroFinance Transparency

“Indifference to evil is worse than evil itself.  In a free society, few are guilty, but all are responsible.”    Abraham Heschel

The microfinance industry continues to suffer a broad range of problems – problems which could rightfully be categorized as evils.  For six years, I’ve been using the above quote to state that though only some of us inside the microfinance industry are “guilty” the rest of us are still responsible to protect the integrity of the industry.  However, with the slow progress we’ve made in countering the problems, my thinking is shifting.  I believe more of us in the industry are arguably becoming guilty.  We are guilty for staying involved in this industry but not taking responsibility to wrestle with the problems that are more and more evident.  Here are four questions for you to consider:

Question 1: What price do we really charge on loans to the poor?

The first step is to understand now to define and measure a price.  You can learn about MFTransparency’s approach here.  So what true prices do we charge?  They are much higher than you think.  And much, much higher than what the outside world (including our clients) thinks.  There are some countries where the prices are not too shocking, at least to those inside the industry.  India, after government intervention, has dropped the prices paid by 20 million clients to below 30%.  But in the Philippines, it is nearly impossible to find a loan at under 30%, and many pay over 100%.  Prices in Cambodia are nearly always under 40%, but prices in Kenya are almost never under 40%.  Immediately to the south, clients are challenged to find a loan under 100% in Tanzania.

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Question 2: What price do we tell the clients we are charging?

Unless government truth-in-lending regulation intervenes, the clients almost never hear the true price of the loan.  You can learn more about what MFT calls the “Transparency Index” at our website.  To take one example, in Ghana, data on loans from 43 MFIs lending to 500,000 clients shows that 60% of those clients are charged flat interest (which doubles the true cost, using a false interest calculation technique); are charged at least one and usually two fees,; are required to buy insurance; and are required to leave part of their loan behind as a compulsory deposit.

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Clients, especially the poor, are always price-sensitive.  They always ask the interest rate, considering that the primary cost of the loan, but in Ghana the interest rate quoted to them is less than one third of the true price they are paying.  If you went to a bank and were told the interest rate is 30%, but not told that the true price was really 90% would you feel you were being manipulated?  In fact, over half the clients in Ghana are paying in excess of 90% per year while being told an interest rate one-third of that amount.  (You can find many interesting country reports, for Ghana and other countries, here.)

Question 3: What price can the poor really afford to pay? (And that is a different question from “willing to pay”)

We have virtually no real data that shows that the poor can pay prices like those we are charging for months and years on end and then be better off financially.  Any objective analysis would certainly cast strong doubts.  A short-term investment loan might generate returns in excess of the interest rates we charge, but any real mathematical analysis would question how a very poor person can pay 100% on a loan balances for multiple years and find themselves with a higher net worth.   Yes, we do find demand for loans at 100% (even though the client doesn’t hear that the price is 100%).  But sadly, even with a clear warning about the true price, decisions about credit are rarely rational.  The poor are generally basing their borrowing decisions on impressions and optimism (and sometimes desperation).  The decisions they make are certainly not always in their best interests.

These are essential numbers for to understand, but we fail to even analyze the data that would lead to understanding.  We would do well to listen to the words of Socrates: “The understanding of mathematics is necessary for a sound grasp of ethics.”

If we are to label ourselves a responsible industry dedicated to improving the lives of our clients we need to dig into the issue of what prices the poor can afford as we much as we do in our favorite institutional ratios of portfolio risk, growth rates, and Return on Equity.  We need more data gathering and more reflection on the broader universe of our 200 million clients, and move away from promotional materials that share vignettes of a handful of success stories.  As a starting point, I challenge us to include some profiles of clients who failed alongside the stories of the successful that we share.

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Question 4: As we have moved briskly into the profit-making world, but still call ourselves responsible businesses, should we have an answer to the question “How much profit is too much profit, when your clients are the extremely poor, and mostly women?”

We do not have an answer to that question.  Some discussions and debates start up on occasion, such as in my video here, but there most certainly is no broad industry position on this issue.  In fact, there are some who argue openly that no profit is too high, even for those claiming the status of responsible businesses.

Personally, I am not against profit.  Most of my 30 years in microfinance have been spent teaching and assisting MFIs around the world to reach sustainability.  But when your clients are the poor and you are operating under the imperfect market conditions of microfinance, you certainly have the opportunity (and arguably the right) to seek the fortune at the bottom of the economic pyramid.  But to do so and label yourself a responsible business operating with the same vision and practices that inspired the awarding of the 2006 Nobel Peace Prize, I disagree.  Strongly.

Moving from Transparent Practices to Responsible Prices

Just a few years ago we were clueless on our true prices.  Now, we may know a bit more than we wished.  We know the prices, and in many cases they are difficult to justify.  We argued that high profits just came from efficiency and satisfied clients, but a look at presentations on our website will show that is far from true.  We urgently need to progress to discussions and definitions of responsible pricing and responsible profits.

We have a moral obligation to establish systems to define and evaluate responsible behavior and to certify those meeting the standards.  Many of us agree on that point, and a number of self-regulation initiatives are under way.  But its hard to believe we are making progress when after 6 years of telling the world that the industry is committed to responsible practice, can we not yet officially name even a single MFI has been judged as not meeting those industry standards.  Time is of the essence.  We must make some hard decisions, and we must make them now.

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One Response to From Opaque, to Transparent, to Responsible Practice

  1. .Dr.V.Rengarajan says:

    Dear Chuck watererfield
    I wish to share my observations on the subject
    1. Although the term Microfinance is casually used, candid microfinance industry in true sense of the term is yet to emerge. So to say I prefer to modify your quote on micro finance industry as “ micro credit industry which does Shylock business in poverty segment, continue to suffer a broad range of problem . Here it is useful for the academia and the students of Microfinance need to discern the difference between micro credit and micro finance package of pro poor services including micro credit distinctly. I have been focusing this point for the last decade.
    2. Regarding the “ Price “ factors . all the four points , focused are academically acceptable , logically sound and ethically respected from client’s perspectives. Perhaps reflecting the ethical concerns of the poor client s this kind of transparency at institutional level would serve ideal . But at the same time from institutional perspectives , a kind of transparency on the rationality for credit decision at client level is absence and this fact questions the validity of the ‘price factors ‘ argued earlier at institutional level.
    3. To wit further on the argumentative point No. 2. above, the non transparent scenario of 5 to 10 loans on an average per poor HH (South Asian context) irrespective of the “price” level ( cost) and type of institutions ( formal. Non formal , informal) & their the norms , is of any indication , then a logical question arises “whether it is the ‘Price’ or ‘ access ‘ which matters most for the client ? If ‘ access’ matters most regardless of the price, then the value of “Price” factors argument diminishes albeit ethical validity from institutional perspectives.
    4. In reality, the driving forces for such irrational credit decision or for not always in their best interest in the client side are aggressive social media on consumer goods and unethical and greedy market environ which led to multiple borrowing and multiple lending with indiscriminate flow of credit without discipline at industry level and overconsumption and over indebtedness at client HH level pushing the concern over the ‘price factor aside or less significant.
    5. This apart, the client’s household and their societal value systems, remaining non transparent , influence the human behavior on credit decision much contrary to outsider rationale
    6. In view of the micro credit industry scenario portrayed above, what is focused here is the need for transparency on the credit behavior pattern at client level as it would facilitate for justifiable credit related matters more transparently at institutional level. In fact such transparency at client level also would also help capturing comprehensive debt position of individual borrowers from all sources in the credit bureau mechanism and avoiding multiple borrowing and multiple lending phenomenon in micro credit industry
    7. In the last , , admittedly it is the price factor which is primary determinant of the income ,scaling and sustainability for the institution . In the context of presence of non transparency of credit decision at client level and dependency on ‘ price factor from the mono credit product for the income of the institution , the micro credit institution (MCI) need to shift from mono credit product to product diversification or integrated MF products ie., savings linked micro credit, insurance linked credit there by meeting the needs of the poor client more ethically and holistically beside finding more sources of income to achieve double bottom line goal respectfully acting as a true Micro Financial Institution ( MFI) In this regard reportedly there is good beginning witnessed in this industry but there is much grass to water.
    Thank you & MoMF for sharing my views
    Dr Rengarajan

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