#tbt: The Need for Pricing Transparency in Microfinance

Muhammad Yunus signs onto the MicroFinance Transparency. With Chuck Waterfield

Muhammad Yunus endorsese the MicroFinance Transparency (MFT). With Chuck Waterfield, MFT founder, at the 2008 Microcredit Summit in Bali.

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We are pleased to bring you this #ThursdayThrowback blog post, which was originally published in The State of the Microcredit Summit Campaign Report, 2009. This particular Box is especially relevant given the news about MFT closing down and the stakeholder meeting hosted by the Microfinance CEOs Working Group on April 21st.

>> Authored by Chuck Waterfield, the developer of Microfin, a business planning tool used by microfinance institutions worldwide, and MicroFinance Transparency (MFTransparency), which was launched at our 2008 Microcredit Summit in Bali, Indonesia.

Microfinance has long been a highly transparent industry, and rightly proud of it. Unfortunately however, the true price of microfinance loan products has never been accurately measured nor reported. For an industry born to displace the moneylenders by providing low-cost credit to the working poor, this is hard to imagine and even harder to explain.

Many countries require commercial lenders to state true product pricing using standards such as the APR (Annual Percentage Rate) formula mandated forty years ago in the US Truth-in-Lending Act. Such laws were enacted to help consumers make informed decisions regarding choosing loan products with different pricing. Currently, the same disparity that existed prior to Truth-in-Lending laws can be found in the microfinance industry. For example, a quoted interest rate of 3% per month can, depending on how this rate is applied, result in an APR between 36% and 96%, and beyond. Unfortunately, such misleading claims are commonplace in microfinance today. Why should the same principles of transparent pricing applied within the commercial finance industry not be applied to the microfinance industry?

The widely practiced non-transparent pricing in microfinance has evolved and perpetuated for two reasons. Firstly, there is no single market interest rate for micro-loans. The industry recognizes that interest rates on micro-loans must be higher than interest rates on larger commercial loans, but it is seldom recognized that there is no single “market rate” for micro-loans. In a market where all MFIs deal with the same cost structures, the smaller the micro-loan, the higher the interest rate necessary for that MFI to cover the costs of that loan and achieve sustainability. Due to the challenges of explaining why MFIs need to charge higher interest rates than the commercial sector, and to charge the highest interest rates to the poorest clients, the easiest alternative has been to use non-transparent pricing, where a quoted price is generally significantly lower than the actual price.

Secondly, once the industry began widely employing confusing product pricing, it became very difficult for MFIs to convert to transparent pricing. To do so, the MFI would advertise what appeared to be the highest price in the market, even though their true price could actually be the lowest. As a result, the vast majority of MFIs practice non-transparent pricing even though many would prefer to do otherwise.

In recent years the industry is shifting from the goal of “sustainable microfinance” to the goal of “high-profit microfinance.” When MFIs are operating in a very opaque pricing environment – where nobody knows how the price of one product compares to the price of another product – there exists the opportunity for MFIs to charge a price that results in very high profit levels. High profits generated off of the poor by charging non-transparent prices can create a bad public image for the microfinance industry and result in a strong backlash.

Given this reality, the industry has been in intensive dialogue and several initiatives are underway to address non-transparent pricing. One initiative is the “Campaign for Client Protection” that began after an April 2008 conference that produced the “Pocantico Declaration.” Transparent and fair pricing is one of the six core principles advocated in the campaign.

The second initiative is MicroFinance Transparency, a non-profit agency that will address pricing transparency through two joint activities. First, MFTransparency will collect product prices on all micro-loan products around the world and report those prices by a common, objective measurement system. Second, MFTransparency will undertake the equally important role of developing and disseminating straightforward educational material to enable microfinance stakeholders to better understand the concept and function of interest rates and product pricing.

It can be argued that an industry-wide effort towards transparent pricing is essential to the long-term survival of the microfinance industry. The mainstream public media is already reporting the interest rates typically charged in microfinance, but there is little explanation or understanding of why microfinance interest rates are higher than previously believed, nor why there is significant variation in interest rates among different institutions. What non-transparent pricing has kept hidden for years is no longer hidden. A forum for the industry must be built in order to report – in a clear, consistent and fair fashion – what actual interest rates are and why interest rates in competitive microfinance markets need to be higher than in commercial finance.

By practicing pricing transparency, a healthy and vibrant market for microcredit products can be built, providing a valuable component necessary in free markets and currently absent in microfinance – transparent, open communication about the true cost of products.

Over 100 microfinance industry stakeholders have endorsed MFTransparency. You may view the list and choose to sign up and endorse at the website.
Chuck Waterfield, Founder, MFTransparency, http://www.mftransparency.org/endorsements.

7 years in transparency

Image credit: MicroFinance Transparency

Image credit: MicroFinance Transparency

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>>Authored by Jesse Marsden, Manager, Research and Operations

If you haven’t read what Mary Ellen Iskenderian (Women’s World Banking) and Michael Schlein (Accion) have to say about the tremendous work of MicroFinance Transparency (MFT) we think you should. “A New Chapter for Pricing Transparency” it is a powerful testament to the importance of the task Chuck Waterfield and his team undertook, enabling a clear and simple means to understand the true cost of the credit products the microfinance industry is providing.

As a direct result of MFT’s methodology, microfinance institutions in many countries now report their pricing data. Multiple institutions also reduced their prices after publishing data and determining that they were out of line with other institutions in their market. Since MFT has been operating, many governments have also started to require pricing transparency in their regulation of the microfinance industry.

MCWG logo

Read the original post by Mary Ellen Iskenderian and Michael Schlein on the Microfinance CEO WOrking Group’s blog!

Womens World Banking and Accion are two of the founding organizations of the Microfinance CEO Working Group (MCWG) who collectively launched Campaign Commitments in 2013. (Read all about it!) This is a consortium of organizations that globally reach over 61 million low income individuals — many among the extreme poor — working together to find synergies and partnerships that make possible their dedication to seeking the highest levels of client protection, social performance, and pricing transparency.

As they say, this is “work that none of us can do alone.” We agree. We are all implicated.

Pricing transparency is one aspect of work that, as they highlight in their article, is an essential part of fulfilling an organization’s mission to serve low-income clients well. This makes pricing transparency important to all actors serving the needs of the poor and extreme poor, whether service provider, market facilitator, policy maker, or investor.

WWB picture blog

Photo credit: Women’s World Banking

The Campaign would hazard to say as well that pricing transparency is a core element to achieving the kinds of pricing models that will help make financial inclusion pathways more affordable to even extremely low-income individuals — an important constituent group to achieving full financial inclusion. (For more on that, check out the Center for Financial Inclusion — another Commitment Making leader!)

We are very glad to be partnered with the MCWG and point to their very thorough Campaign Commitment as an example of the kind of multi-faceted and collaborative approach needed to make headway in using financial and social services to help end poverty. We second the call from the MCWG to combine “successful data collection…advocacy, education, training, and funding” to ensure that pricing transparency remains a central pillar to sustainable and full financial inclusion.

Institutions that do not comply are not “getting away with it”; they do not belong in this industry. Pricing transparency should never be a threat to competitive advantage, but a requirement to operate as a responsible microfinance institution.

We look forward to a continued partnership with the MCWG in finding ways to strengthen the financial inclusion pathways for all those living below the poverty line.

We also would like to acknowledge the interesting conversation that has been happening on the Microfinance Practice Yahoo! Group listserv. Chuck made the announcement about MFT closing its doors there and the outpouring of support and the testimonials of personal experience either with MFT specifically or with price transparency in general has been enlightening. We encourage you to join the listserv as it is a valuable resource for a frank conversation about relevant issues with your peers.


A Time of Reckoning


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