This is a continuation of Oikocredit USA’s Microfinance Investor Education Series, or MIE Series, designed to educate investors, donors and advisors about social impact issues in microfinance investing. Alexandra Fiorillo at MicroFinance Transparency, our guest blogger, presents her second installation of MFTransparency’s three-part series on pricing transparency. The first installation identified the two main issues that contribute to non-transparent pricing in the microfinance sector: no single pricing for micro-loans and no single pricing methodology. This installation will take us deeper into the lack of a single price for micro-loans.
Microfinance clients benefit from clear and easy to understand pricing of financial products. Clients can make better financial decisions if prices from one institution to another are easily comparable.
In my previous blog, I identified two reasons for lack of transparent pricing in microfinance: 1) there is no single market for micro-loans, and 2) there is no single pricing methodology used in the industry. In this installation, I will delve more deeply into the market context and conditions that result in a lack of a single market price for micro-loans.
Microfinance pricing is complicated and data shows there is not one single price for any type of microloan product, regardless of lending methodology (group loan, individual loan, etc.) or purpose (business, housing, etc.), around the world. In fact, seemingly similar microfinance loan products offered by several financial institutions in a given market, such as business loans borrowed by groups in Rwanda, could have very different prices. When you have multiple loan providers in one market with a variety of operational characteristics, serving different market segments (low –moderate income, rural vs urban, etc.) and no standards for pricing disclosure, this could mean confusion for borrowers. If the same product has different prices and these prices are communicated in different forms (e.g. interest rate only vs. fee plus interest), how can a client compare prices and choose the best option available?
Investors and donors trying to understand the issue of pricing transparency in the microfinance sector should recognize the challenges in analyzing and deciphering “market price” within the market — across the microfinance industry broadly as well as within specific country-markets.
On the Market Level
A common and flawed assumption is that all microloans that serve the same market carry the same price. This is not true. Prices can vary significantly in some markets. Take a look at the wide fluctuations in Figure 1 (below) showing nominal portfolio yield rates, a proxy for price, for financial institutions of several countries that reported to the MIX Market in 2009. Nominal Portfolio Yield has often been used as a representation for the “price” of a microloan because it tells us how much an institution has earned through its lending operations. For years, this has been the best representation of the “price” an institution charges its clients.
Here is a fictional example of two microfinance institutions (MFIs) to help you understand how nominal portfolio yield serves as a proxy for pricing:
This means, theoretically, that for every average dollar loaned, MFI A made $0.20 and MFI B made $0.30. In the early days, when MFIs offered only one product each, the portfolio yield was a useful proxy. When MFIs started adding more products but charged nearly the same price for each product, portfolio yield was still sufficient. Now, however, MFIs are more sophisticated in their pricing and this is no longer the case. Today’s microfinance institutions offer multiple products to various market segments and these products often carry different prices. Thus, the average portfolio yield can be highly misleading for understanding what borrowers are actually paying. For example, an MFI with an average portfolio yield of 30% could mean an institution is charging a 25% price on one product and 80% on another product. If the product priced at 25% constitutes more of the loan portfolio, the Nominal Portfolio Yield will be skewed downward, obscuring the existence of the much more expensive product.
This graph looks confusing because it is! Whether you are looking at Bangladesh, El Salvador, or the Philippines, a variety of differences in the market context mean that identifying the average “market” price will be extremely difficult. Looking across different microfinance markets around the world, it becomes impossible to say what the average or “market” price in the microfinance industry is since the nominal portfolio yields are so different by country.
On the Institution Level
For years, analysts in the microfinance sector have tried to identify an “average price” in a given market by looking at institutional portfolio yields. Many people have considered average portfolio yield for a specific country’s microfinance market to be an accurate representation of the average price of a microloan. Figure 2 shows the portfolio yield for 23 financial institutions with varying institutional characteristics and product lines in Bolivia. The yield ranges from 13% to 37%. Can you really say what the “market price” is in Bolivia?
The Importance of Loan Size
Figure 3 below presents the nominal institutional portfolio yields with the average outstanding loan balance for 23 MFIs in Bolivia. There are two important messages in this graph. First, let’s take a look at the downward sloping curve: the curve indicates that institutions with higher average outstanding loan balances earn lower yields on their portfolios while the institutions with the smallest outstanding loans have the highest yields. In other words, it looks like institutions that provide bigger loans charge a lower price, while institutions that provide smaller loans charge a higher price.
But remember – yield is no longer an accurate representation of price when an institution offers multiple products at multiple prices. This means that it is impossible to tell from this graph alone if low-income borrowers of institutions that also provide loans to up-market clients receive low or high prices. The second message is reflected in the dots in the area circled in red: here, we see that there is a range of yields being earned on loans of similar size. What we don’t know from this graph is the real price that is articulated to the client when she or he takes a loan from an institution. In other words, how is the price reflected – as an interest rate, fee plus interest rate or some other formulation?
When we look at real pricing data collected by MicroFinance Transparency and use the Annual Percentage Rate (APR) calculation to represent price, we see a similar curve as the portfolio yield curve above (Figure 4, below). However, this graph shows actual prices paid by clients in the market. The image below shows us APR data for a number of institutions in Bolivia correlated to loan size. What we see is that for every loan size, there is often a range of prices available in the market.
If you wanted a loan of 5,000 Bolivianos, you could pay anywhere between 20% and 70% APR. Similarly, for different types of loans (business, consumption, housing, etc.) there is not one set price but a range of prices being offered in the market. When we look at the Bolivia data just for business loans, below, we see that there is still a wide range of prices offered at different loan amounts. How can a client determine what the market rate for a business loan is in this case? What would you say the market price for a microloan in Bolivia is given this information?
The answer is there isn’t one. Different institutions offer different products with different features to different market segments in a given country. Each institution has a unique cost structure that influences its loan pricing strategy and contributes to the wide variety of prices in one market. It is only when we look at real pricing data, segmented by loan purpose, loan size and other features that we begin to see how complicated and varied microfinance pricing can be.
Pricing can be even more complicated when you consider the different terms applied to any given loan product. In the next post I will discuss pricing on the borrower level, taking a look at the factors that clients are faced with when making a decision about borrowing.
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 policy makers, microfinance investment vehicles, MFIs and other financial institutions serving low-income communities on consumer protection and financial transparency.