This is a continuation of Oikocredit USA’s Microfinance Investor Education Series, or MIE Series, designed to educate investors, advisors and fiduciaries about social impact issues in microfinance investing. Today’s blog is the first of a series of Guest Blogs by Alexandra Fiorillo at MicroFinance Transparency.
Perhaps one of the most difficult – yet necessary – advancements in microfinance has been transparent pricing. The true price of microfinance loan products has rarely been accurately measured. What does true price or transparent pricing mean in microfinance? The global, working definition of transparent pricing means the pricing, terms, and conditions of loans will be adequately disclosed to the clients in a clear manner that allows both accurate understanding of prices and comparison of different products. The terminology itself is important. The interest rate is one of several charges and terms that affect the overall cost of borrowing. Using the word “pricing” rather than “interest rates” is more comprehensive.
MicroFinance Transparency, in close collaboration with the Smart Campaign and other industry leaders in the consumer protection field, has helped to identify this working definition. Microfinance, an industry born to displace the moneylenders by providing low-cost credit to the working poor, needs to ensure that its clients have clear information about the cost of the money they borrow.
Unfortunately, non-transparent pricing in microfinance has pervaded for two main reasons:
1. There is no single market price for micro-loans. Every country’s market is unique and microfinance service providers differ even within countries based on many dimensions. Financial institutions servicing the microfinance market face higher operational costs due to the fact that they serve many clients but each client only takes out a very small loan. This fundamental characteristic of high operating cost ratios is strongly related to why MFIs need to charge higher rates than the commercial sector, and to charge the highest rates to thepoorest clients. Due to the challenges of explaining this, MFIs tend to use pricing methods where the quoted price appears significantly lower than the actual price.
2. There is no single pricing methodology. Throughout the industry, different product pricing methods are employed – using both declining and flat methods of calculating interest, charging upfront and ongoing fees, quoting interest in annual, monthly or weekly terms – making it very difficult for any one MFI to convert to straightforward, standardized and transparent pricing. To do so would leave that MFI advertising what appeared to be the highest price in the market, even though their true price could actually be the lowest.
MicroFinance Transparency (MFTransparency) is working to address these challenges in nearly 30 countries around the world. To promote industry-wide standards of transparency, we have collaborated with a group of social investors to ensure financial institutions comply with pricing standards and disclose the true prices of their loan products. An early leader in the transparent pricing movement among social investors, Oikocredit endorsedMFTransparency in 2008 and committed to encouraging more transparent pricing communication on the part of its MFI investees to their borrowers. Oikocredit and other social investors have used our Calculating Transparent Prices Tool to better monitor the pricing of their portfolios. Social investors and donors are in the unique position to be able to set standards and expectations for their partner institutions. We encourage more social investors to require their partners – new and old – to participate in the Transparent Pricing Initiative by:
- Submitting microloan pricing data to MFTransparency and updating their data annually; and,
- Working with MFTransparency to improve the loan documents given to clients in order to ensure they are clear and communicative
As microfinance institutions improve the way they calculate and communicate prices, and as investors and donors hold their partners to higher standards of responsibility, we can begin to ensure that micro-loan clients receive clear pricing information that allows them to make informed choices. By practicing pricing transparency we contribute to building a healthy and vibrant market for microcredit products in each country, providing a valuable component necessary for free and competitive markets to develop – transparent, open communication about the true cost of our products.
As COO of MicroFinance Transparency, Alexandra Fiorillo manages the Global Programs department with projects in 30 countries. Based in New York City, she trains regulators and policymakers, microfinance investment vehicles, MFIs and other financial institutions serving low-income communities on consumer protection and financial transparency.