Price Transparency &
Truth-in-Lending
MS. AZISH FILABI
African Leadership Forum – June 2013
Disclaimer
The views expressed in this presentation are
solely my own
Why is transparency important?
Hidden Prices!!
Theory of Truth-in-Lending
• It is a disclosure standard (not a price control)
• Consistent with free market economic
principles, disclosure ensures that both
borrower and lender have the same
information
– Fixes a market distortion caused by information
asymmetry
– In theory, in a transparent market, prices should
converge
Why legislation?
• Stakeholder incentives:
– Lenders– want to reach more clients, therefore incentive
to provide lowest sounding price (hidden fees)
– Investors – want higher volume and higher returns
– Client – wants the best deal, but may not know what to ask
for
• Mandatory participation required for a disclosure
regime to work efficiently
– Self-regulation is voluntary
– Transparency works best when consistent – clients should
be able to compare the same information, ideally in the
same format
Why legislation?
• Self-regulation has no enforcement mechanism
– Reliance on market forces to distinguish among MFIs
– Self-regulation demonstrates a commitment to responsible
finance, which is a important step for truth-in-lending laws
to work effectively
• The main benefits to competition and fair access
come from all lenders adhering to the same rules
Legal Considerations &
Best Practices
Legal Considerations
1.
2.
3.
4.
Standard Pricing Formulas
Standard Repayment Schedules
Enforcement & Sanctions
Financial Education/Communication
Mechanisms
1. Standard Pricing Formulas
• Why a standard formula?
– Beneficial to clients when all lenders use the same formula
(so borrowers can compare “apples to apples”)
• What disclosure standard?
– Nominal rates: dismissed because it does not provide
adequate disclosure of the “real” rate
– APR vs. EIR vs. Total Cost of Credit? APR is a best practice
– Should flat interest rates be prohibited?
– Mandatory savings accounts to be included in cost
calculations?
1. Standard Pricing Formulas
• What fees disclosed?
– Best practice would require ALL origination or repayment
fees to be communicated
• How to best disclose bundled services?:
– Insurance
– Mandatory savings; voluntary savings
• Other Terms & Conditions
– Prepayment penalties?
– Variable or fixed interest rates?
1. Standard Pricing Formulas
Philippines
• Bangko Sentral ng Pilipinas (Central bank) regulates
microfinance “banks” (General Banking Law of 2000)
– microfinance market has non-bank microfinance lenders,
and also traditional commercial banks
– www.frbsf.org/publications/.../2010/january.pdf
• The Truth In Lending Act (Republic Act 3765) (1963)
– Applies to all “creditors”
• Flat interest rates prohibited (Circular No. 730, Series of 2011)
– “Banks may only charge interest based on the outstanding
balance of a loan at the beginning of an interest period.” (
1. Standard Pricing Formulas
Philippines
• Mandatory disclosures – Definitions:
– “Finance charge includes interest, fees, service charges,
discounts and such other charges incident to the extension
of credit” (Circular No. 730)
– Permitted to use EIR or MPR (may confuse the market)
• “…effective interest rate (EIR) is the rate that exactly
discounts estimated future cash flows through the life
of the loan to the net amount of loan proceeds
(Circular No. 730; see examples in Memorandum M2011-040)”
• “for loans with contractual interest rates stated on a
monthly basis, the EIR may be expressed as a monthly
1. Standard Pricing Formulas
• How to further protect consumers?:
– Prohibit a mandatory security interest/collateral
accounts
Legal Considerations
1.
2.
3.
4.
Standard Pricing Formulas
Standard Repayment Schedules
Enforcement & Sanctions
Financial Education/Communication
Mechanisms
2. Standard Repayment Schedules
• Why standard?
– Standard forms make it easier to compare across
lenders, irrespective of entity type
– For illiterate clients, a standard form makes it
easier to compare offerings even if they don’t
necessarily understand all the terms
2. Standard Repayment Schedules
• Should forms be mandatory or used at the
discretion of the lender (a safe harbor)?
– Mandatory use will ensure consistency
– Safe harbor reduces compliance costs and
provides opportunity for experimentation
• What level of detail in the forms?
– Balance of too much info vs. sufficient info (risk
confusing clients)
– Only APR/EIR/TCC?
– Include cash flow details?
2. Standard Repayment Schedules
Philippines
• Disclosure mechanisms:
– Mandatory disclosure of the following information:
1) the cash price or delivered price of the property or service to be acquired;
(2) the amounts, if any, to be credited as down payment and/or trade-in;
(3) the difference between the amounts set forth under clauses (1) and (2);
(4) the charges, individually itemized, which are paid or to be paid by such person in connection with the
transaction but which are not incident to the extension of credit;
(5) the total amount to be financed;
(6) the finance charge expressed in terms of pesos and centavos; and
(7) the percentage that the finance bears to the total amount to be financed expressed as a simple annual rate on
the outstanding unpaid balance of the obligation.
– Provides a disclosure statement (unclear whether this is
just a suggested standard)
– Disclosure form requires a signature
– Borrower’s rights must be posted on business premises
Legal Considerations
1.
2.
3.
4.
Standard Pricing Formulas
Standard Repayment Schedules
Enforcement & Sanctions
Financial Education/Communication
Mechanisms
Enforcement & Sanctions
• Disclosure regimes will require enforcement &
sanctions to be most effective
• Various enforcement regimes & models to be
explored by the Working Group:
– Recommendations will differ based on regulatory
landscape & scale of lending in each jurisdiction
Enforcement & Sanctions
• Example – United States
• entities that are prudentially supervised are often
sanctioned by the licensing or supervisory agency (OCC,
FDIC, State Banking Dep’t, Federal Reserve); and
• ALSO subject to supervision by agencies with legal
jurisdiction over their activities or financial products
(Consumer Financial Protection Bureau; Federal Trade
Commission);
• ALSO can be subject to sanction by the State Attorney
General’s office; AND
• Borrowers have remedies under the Truth in Lending Laws
Enforcement & Sanctions
•
U.S.: Remedies for consumers under US Truth in Lending law
– Rescission: Right to rescind (cancel) a loan where a customers principle
dwelling is taken as collateral, other than transactions for purchase of a home.
Commonly rescinded transactions include home equity loans, loans for home
improvement, and refinance loans. The right exists for 3 days, and in some
cases can go up to 3 years [if important TILA disclosures were not made]
– Actual damages (must prove how much); individual statutory damages
(ranging from $200 to $4,000); class action statutory damages; and attorney
fees; and sometimes injunctive relief (common law remedy)
– Regulators can impose enforcement actions on entities that do not comply
Enforcement & Sanctions
Philippines
•
•
Statutory Damages: (a) Any creditor who in connection with any credit transaction fails to
disclose to any person any information in violation of this Act or any regulation issued
thereunder shall be liable to such person in the amount of P100 or in an amount equal to
twice the finance charged required by such creditor in connection with such transaction,
whichever is the greater, except that such liability shall not exceed P2,000 on any credit
transaction. Action to recover such penalty may be brought by such person within one year
from the date of the occurrence of the violation, in any court of competent jurisdiction. In
any action under this subsection in which any person is entitled to a recovery, the creditor
shall be liable for reasonable attorney's fees and court costs as determined by the court.
Criminal Sanctions & Penalties: (c) Any person who willfully violates any provision of this Act
or any regulation issued thereunder shall be fined by not less than P1,00 or more than
P5,000 or imprisonment for not less than 6 months, nor more than one year or both.
• Republic Act No. 3765
Others Practices
India
• Microfinance Crisis (Andra Pradesh)
– Over-lending: cases of multiple MFIs borrowing
from multiple microfinance institutions
– Loans were insured, so some borrowers that
couldn’t repay thought that their family would be
better-off if the borrower committed suicide
– Aggressive collection practices by some MFIs
– Much coverage in the press; government
intervened to close many branches and later
responded with regulations
India
• Reserve Bank of India (central bank) initiated
new consumer protection regulations
• Begin to regulate Non-bank Microfinance
Financial Companies (DNBS.CC.PD.No. 250/03.10.01/2011-12)
• Ban flat interest rates (Sec 4.C.a.ii of 2011 Directive)
– “Interest on individual loans will not exceed 26% per annum and
calculated on a reducing balance basis”
• Prohibit use of mandatory security deposit
collateral accounts (Sec 4.C.b.i.c)
– “MFIs shall not collect any Security Deposit/Margin from the
borrower”
India
• Caps
– 2011: for individual loans, interest rate cap of 26% + 1% max
fees + 12% margin cap (insurance fees can be charged
separately)
• Loan pricing can only be impacted by the interest charge, the
1% processing fee, + insurance premiums (including their
administrative fees)
– 2012: to allow operational flexibility, they loosened the interest
rate cap
• average interest rate on loans during a year does not exceed
the average borrowing cost during the year + the margin cap
• Reduced margin cap to 10% for large MFIs (loan portfolio
exceeding Rs. 100 crore); 12% for smaller
India
• Mitigate over-lending to same borrowers
– “not more than 2 non-bank MFIs should lend to
the same borrower”
– “a borrower cannot be a member of more than
one Self Help Group/Joint Liability Group”
• Recovery methods
– Recovery at a borrower’s place of residence only if
borrower fails to appear at designated place on 2
or more occasions
– MFIs shall have a Code of Conduct in force
U.S.
• New Consumer Financial Protection Bureau (CFPB), part of the DoddFrank Act
• U.S. truth in lending law focuses only on consumer lending
• Various laws address transparency – the laws are aimed at categories of
credit: - for example:
– Reg C – Home Mortgage disclosure
– Reg Z – Truth in Lending (consumer loans, including mortgages)
– Reg B – Equal Credit Opportunity Act (applies to all lending, i.e., anyone who is a
“creditor” under the law)
– Reg E – Electronic Fund Transfers – applies to all entities that hold accounts belonging to
a consumer for fund transfer purposes
• CFPB has engaged in an initiative to streamline disclosures – consumers
had received too much information
U.S.
• Finance Charge definition (TILA, Section 106)
– “…the amount of the finance charge in connection with any consumer credit transaction
shall be determined as the sum of all charges, payable directly or indirectly by the
person to whom the credit is extended, and imposed directly or indirectly by the
creditor as an incident to the extension of credit…”
– “Examples of charges which are included in the finance charge include any of the
following types of charges which are applicable: (1) Interest, time price differential, and
any amount payable under a point, discount, or other system or additional charges; (2)
Service or carrying charge; (3) Loan fee, finder’s fee, or similar charge; (4) Fee for an
investigation or credit report; (5) Premium or other charge for any guarantee or
insurance protecting the creditor against the obligor’s default or other credit loss; (6)
Borrower-paid mortgage broker fees, including fees paid directly to the broker or the
lender (for delivery to the broker) whether such fees are paid in cash or financed”
• Annual Percentage Rate definition (TILA, Section 107)
– “…that nominal annual percentage rate which will yield a sum equal to the amount of
the finance charge when it is applied to the unpaid balances of the amount financed,
calculated according to the actuarial method of allocating payments made on a debt
between the amount financed and the amount of the finance charge, pursuant to which
a payment is applied first to the accumulated finance charge and the balance is applied
to the unpaid amount financed…”
U.S. Model Form
U.S., continued
• U.S. is heading towards a regime of mandatory forms:
– “The CFPB believes, based on consumer testing results, that the
purpose of more effective advance disclosure of settlement costs is
better achieved if all lenders provide those disclosures in a
standardized format that consumers can recognize and understand.
Moreover, the credit terms included in the Loan Estimate facilitate and
enhance the consumer's ability to shop for the best-priced loan,
including settlement charges, which have a direct relationship to, and
can overlap with, credit terms.” [Federal Register 37(o)(3)]
Cambodia
• Law on Banking and Financial Institutions
(1999)
– Identify microfinance lenders as banks
– Prakas on Microfinance Licensing (2000), provides
for compulsory MFI licensing & registration
• Interest rates must be calculated on the
declining balance method
• For savings accounts, compounding of interest
is required
• Pricing information must be published on the
MFI websites
UNCITRAL
UNCITRAL
• UN Commission on International Trade Law
• Est. by UN General Assembly (GA) in 1966
• Membership– elected by the GA. 60 states:
– 14 African
– 14 Asian
– 8 Eastern European
– 10 Latin American & Caribbean
– 14 Western European & other states
UNCITRAL
• Term – 6 years. Every 3 years, terms of half of
the members expire
– Non-member states are permitted to attend
sessions
• Methods of Work
– 6 Working groups (substantive issues assigned to
each one)
– Texts: Conventions; Model laws; Legislative guide
and recommendations;
UNCITRAL
• Studying microfinance since 2009
– Current proposal is to consider an enabling legal
environment for micro, small and medium-sized
enterprises. Considering the life cycle of a MSME.
– Among MSME topics: 1) simplified business formation; 2)
effective dispute resolution; 3) mobile payments; 4)
transparency in lending, credit reporting systems; and 5)
insolvency of a MSME
• Balance “over regulation” with “under regulation”
– Timing of implementation will be country-specific: legislators, regulators, and
local organizations are the best positioned to determine implementation but
UNCITRAL is best position to provide standards
Importance of Transparency
AS REPORTED BY THE UNCITRAL SECRETARIAT
• “A recurring theme [of the 1st Int’l Colloquium on Microfinance in 2011]
was the need for measures to ensure client protection, including the
prevention of unscrupulous practices and the building of financial literacy
in the community generally”
• “As noted, self-regulation by itself is no longer sufficient and there is an
increasing consensus on the need to follow the principles of responsible
finance.”
• “More generally the need for transparency (e.g. interest rate disclosure,
complaint procedures) in the microfinance sector was flagged.”
Note by Secretariat (summary of First Int’l Colloquium on Microfinance),
Legal and regulatory issues surrounding microfinance, A/CN.9/727
(2011)
UNCITRAL
• Potential approaches for a project on
Microfinance and Related Topics:
– Legislative Guide -- enables legislators and
regulators to implement transparency regimes
• Opportunity to identify best practices among countries
and incorporate in to a Guide
• A Guide is not legally binding on any States, it’s a tool to
assist implementation of new laws
Additional Materials
Importance of Transparency
AS RECOGNIZED BY THE INDUSTRY
• Smart Campaign – Client Protection Principles
– 2 of the 9 Principles include Transparency, and Responsible Pricing
– Self-certification, and recently third party certification launched
– www.smartcampaign.org
• Banana Skins reports:
– Reputation risk (2011) and political interference (2012)
– These reports are written by practitioners in the microfinance industry based on
information received by surveys of various stakeholders
– Increasing perception that MFIs engage in abusive practices
– Recognition that abusive practices are not only detrimental to the client but also to
the long-term credibility of microfinance
– http://www.citigroup.com/citi/microfinance/data/news110125b.pdf
• Microfinance Rating Agencies
– Planet Rating/Microrate/Microfinanza: Specialize in rating MFIs
– Have added (as of 2012) client protection (including transparency, responsible
pricing and effective complaint resolution) as a pillar of an MFI rating
– “An MFI lives in symbiosis with its clients and its asset quality is notably based on
the trust relationship created with its clients”. Planet Rating
– “Client protection and other social measures are essential to the long-term success
of the business…” Microfinanza
Importance of Transparency
OTHER REPORTS
• “Countries with a strong institutional framework for
microfinance (as defined by the Microscope) tend to
reach more borrowers than countries with weaker
institutional conditions. This observation especially
holds true for countries with transparent pricing
regulations and good dispute resolution
mechanisms.”
Global microscope on the microfinance business environment (2012),
Economist Intelligence Unit. www.eiu.com/microscope2012
Financial Education
• Client Education:
– With transparency pricing, prices may appear
higher (because all costs are now included), so
clients should be educated on the differences
• Lenders/MFIs may need training on how to
comply with disclosure laws
– Will vary by country and population
Communication Mechanisms
• Communication of information disclosed
should be calibrated to the level of financial
education of clients
– See CGAP Focus Note No. 78 (March 2012), Designing Disclosure
Regimes for Responsible Financial Inclusion (where they recommend
consumer testing and feedback mechanisms to understand MFI
clients).
Communication Mechanisms
• Communication Mechanisms:
– Placement of required disclosure:
• In loan documents? At MFI branches? In newspapers? On
websites? Directly to regulators?
– Working Group to consider complexities of communicating
information to lower-income borrowers and their needs
• Oral communication requirements?
• Clients be required to acknowledge understanding?
• Mandate on the timing of disclosure? Cooling off periods?
Thank You!