Responsible Finance: Embedding
Consumer Protection Principles into
Cross-Border Financings Offered to
Microfinance Providers
Deborah Burand
Director, International Transactions Clinic
University of Michigan Law School
What is microfinance?
Microfinance is often defined as financial services for poor
and low-income clients. In practice, the term is often used
more narrowly to refer to the loans and other services from
providers that identify themselves as “microfinance
institutions” (MFIs).…
More broadly, microfinance refers to a movement that
envisions a world in which low-income households have
permanent access to a range of high quality financial
services to finance their income-producing activities, build
assets, stabilize consumption, and protect against risks.
These services are not limited to “microcredit,” but also
include savings, insurance, and money transfers.
Source: CGAP website, www.cgap.org (What is Microfinance?)
“Halo effect” of 2006 Nobel Peace
Prize Awarded to Muhammad Yunus
and Grameen Bank
“Today, Grameen Bank gives loans to nearly 7.0
million poor people, 97 per cent of whom are
women, in 73,000 villages in Bangladesh.
Grameen Bank gives collateral-free income
generating, housing, student and microenterprise loans to the poor families and offers a
host of attractive savings, pension funds and
insurance products for its members.” Nobel Lecture
delivered by Muhmmad Yunus (December 10, 2006)
Profitability: A Growing Driver
In India, Vikram Akula, the founder of SKS
Microfinance, the country’s largest microlending bank, says he is modeling his growth
plans on “Coke, Starbucks and McDonald’s.”
He describes Yunus as his “inspiration”, but
says it is time for a younger generation of
bankers to “push it to the next level ... with
the unabashed goal to be extremely
profitable.”
•
Source: The Sunday Times, October 4, 2009, “World poverty guru ‘fails’ to spread wealth”
Boom in microfinance
2000-2007 Total Assets of MFIs (USD bn.)
(reported to MIX)
60
50
40
30
20
10
0
2000
2001
2002
2003
2004
2005
2006
2007
Source: CGAP analyzing MIX Market data. Total assets are for all MFIs reporting to the MIX market. As of July 2009, 1400 MFIS were
reporting to the MIX.
Quantity at expense of Quality?
Survey of 430 respondents from 82 countries and
multinational institutions … biggest risk
confronting microfinance sector today is credit
risk.
Source: Microfinance Banana Skins Report 2009: Confronting Crisis
and Change
“… over-indebtedness of clients is emerging as a key
problem in the microfinance sector.”Sanjay Sinha,
Managing Director of M-CRIL quoted in Microfinance Banana Skins
Report 2009
What are key consumer protection
challenges in microfinance?
- Lack of transparent pricing on credit products
- Over-indebtedness of clients
- Unclear/one-sided loan agreements favoring
Lender
- Inappropriate debt collection practices
- Lack of accessible/affordable dispute
resolution processes (including lack of
consumer advocates)
How have actors in microfinance
sector responded to consumer
protection issues?
• Self-regulation and self-assessment by MFIs
• Adoption of codes of conduct by MFIs and
local/international networks
• Market conduct regulation imposed by local supervisory
authorities
• Recent launch of consumer protection research and
action/resource/policy initiatives (Campaign for Client
Protection launched in March 2009; Microfinance
Transparency launched in July 2008)
• Endorsement of Client Protection Principles by MFIs,
Donors and Investors
Microfinance Transparency Launched
Client Protection Principles
1. Avoidance of Over-Indebtedness. Providers will take reasonable steps to ensure that credit will be
extended only if borrowers have demonstrated an adequate ability to repay and loans will not put
the borrowers at significant risk of over-indebtedness. Similarly, providers will take adequate care
that non-credit, financial products (such as insurance) extended to low-income clients are
appropriate.
2. Transparent Pricing. The pricing, terms and conditions of financial products (including interest
charges, insurance premiums, all fees, etc.) will be transparent and will be adequately disclosed in
a form understandable to clients.
3. Appropriate Collections Practices. Debt collection practices of providers will not be abusive or
coercive.
4. Ethical Staff Behavior. Staff of financial service providers will comply with high ethical
standards in their interaction with microfinance clients and such providers will ensure that
adequate safeguards are in place to detect and correct corruption or mistreatment of clients.
5. Mechanisms for Redress of Grievances. Providers will have in place timely and responsive
mechanisms for complaints and problem resolution for their clients.
6. Privacy of Client Data. The privacy of individual client data will be respected, and such data
cannot be used for other purposes without the express permission of the client (while recognizing
that providers of financial services can play an important role in helping clients achieve the
benefits of establishing credit histories).
Source: Center for Financial Inclusion at ACCION, www.accion.org.
Investor Responses
“I hope and think that MFIs that will embed client
protection principles into their core business activities
will have a competitive advantage, with all
stakeholders: not just with clients but with investors,
donors, governments, and policy makers.
Pricing transparency along with efficiency and yield
analysis shows the organisation understands the nature
of its business and is actively managing its margins and
how they are allocated to different shareholders .” -JM, Triodos Bank (Source: Microfinance Transparency, October 2009
presentation)
MIVs:
independent investment entities that specialize in microfinance with
at least 50% of portfolio in microfinance
Assets under management in top 10 MIVs
reached USD$4 billion in 2008
2007 USD
116
114
Omidyar/Tufts Fund
Dual Return Fund, Vision Microfinance Subfund
ASN-Novib Fund
responsAbility SICAV (Lux) Microfinance Leaders Fund
SNS institutional Microfinance Fund
2008 USD
55
116
120
122
160
201
117
responsAbility Global Microfinance Fund
Dexia Microcredit Fund
Oikocredit
EFSE
Pro Credit Holding AG
Source: CGAP Presentation, October 2009
243
193
378
298
429
569
632
587
745
800
1019
Investor Responses
CGAP 2009 MIV Survey found that:
-- there were 103 MIVs with Assets under
Management (AUM) of USD$6.6 billion as of
December 2008
-- of these MIVs, 63% have endorsed the Client
Protection Principles*
(* Nearly equal amount (61%) report ESG information
to investors)
Endorsement of Client Protection
Principles
As of December 1, 2009, over 90 investors and
donors to the microfinance sector had
endorsed the Principles. Source: Center for Financial
Inclusion at ACCION International (www.accion.org)
But how meaningful are these investor/donor
endorsements at changing behaviors of MFIs
(or of the investors/donors)?
Recommended Actions for Investors
1.
2.
3.
4.
5.
6.
7.
Incorporate the Principles into investment policies.
Endorse the Principles publicly.
Encourage current and prospective investees to discuss and endorse the
Principles.
Develop, test, and refine criteria and procedures to assess investee
implementation of the Principles during screening and due diligence
processes.
Integrate the Principles into financing or shareholder agreements, as
appropriate.
Monitor implementation of the Principles by investees through
mandatory reporting and regular monitoring and evaluation.
Report on progress to investors and other stakeholders.
Source: Implementing Client Protection Principles: A Technical Guide for Investors
(published by CGAP September 2009)
Embedding Consumer Protection
Principles into Cross-Border Financings
BUT …
In this early stage, most investors are NOT integrating the Principles into the
documentation evidencing their financing or shareholder agreements with
MFIs
They also typically are NOT requiring current or prospective investees to join
Campaign for Client Protection and endorse the Principles
Instead, most investor focus is on (i) incorporating the Principles into
investment processes – screening, due diligence, raising awareness in
conversations with potential MFI investees, and monitoring/evaluation of
investments, and (ii) reporting on progress to shareholders and other
stakeholders
Source: Implementing the Client Protection Principles: A Technical Guide for Investors (September 2009)
KfW: First Mover at Embedding Consumer
Protection Principles into Documentation for
Cross-Border Financings of MFIs
“The Borrower shall fully comply with all existing and future national laws and
regulations on consumer protection especially in the area of financial
services. The Borrower shall in particular provide its customers with clear
and comprehensive information on the main characteristics of the
financial services the customers seek. The Borrower shall, for example,
have thoroughly informed its customers in good time before the signing of
the loan agreement on the terms and conditions of the loan in a way
easily understandable for the customer.
These loan agreements shall further contain such information and shall be
drafted in a manner the customers are able to understand. Furthermore,
the Borrower shall critically review the customer’s repayment capacities
before signing a loan agreement and shall refrain from any form of unfair
or even harmful debt collection practices.”
Excerpt from KfW form of loan agreement
Local Laws and Regulations
“The Borrower shall fully comply with all existing
and future national laws and regulations on
consumer protection especially in the area of
financial services.”
Question: Are local laws and regulations on
consumer protection in financial services
developed enough to give this covenant some
teeth?
Answer: Mixed
Tanzania
Article 27.(1) The contract between the bank or financial institution and the borrower,
must state the nominal rate, as well as commissions and fees, either on an annual
or a monthly basis.
(2) The borrowers shall be permitted to make partial or total prepayments on their
microcredits. Penalties for prepayment, if any, shall be described in the contract.
(3) It shall be prohibited to impose or assert any contractual term or condition
granting the Microfinance Company authority to introduce unilateral modifications
to interest rates or other loan conditions.
(4) Microcredit contracts may establish an indexed interest rate, designed to vary in
line with a reference rate published by the Bank.
(5) The Bank shall monitor the collection practices of institutions engaged in
microcredit and shall instruct institutions to discontinue those that, in its opinion,
are abusive.
Source: Microfinance Companies and Microcredit Activities Regulations 2004.
Zambia
30.(1) A deposit taking microfinance institution that provides credit facilities
to a customer shall at the time of providing the service, in a statement in
writing, disclose to the customer concerned the cost of borrowing….
31.(1) A microfinance institution shall display in a conspicuous place on the
premises of every branch where it conducts business a notice containing –
(a) a clear and simple summary of the business conducted by the
microfinance institution;
(b) information on customer rights and responsibilities;
(c ) details on the financial products offered; and
(d) the terms under which any financial product is offered.
Source: Statutory Instrument No. 3 of 2006 (January 30, 2006); The Banking and Financial Services (Microfinance)
Regulations, 2006.
Truth in Lending/Transparency
“The Borrower shall in particular provide its
customers with clear and comprehensive
information on the main characteristics of the
financial services the customers seek. The
Borrower shall, for example, have thoroughly
informed its customers in good time before
the signing of the loan agreement on the
terms and conditions of the loan in a way
easily understandable for the customer.”
Why encouraging transparent pricing
in microfinance is so hard
• There is no “single interest rate” or consensus yet for how to
communicate to customers the comparable costs of similar
microfinance products
• MFIs have very different products and they need to be priced very
differently
• Difficult to communicate and educate the public about these issues
• Disclosing actual effective interest rates can be politically sensitive
• There can be a “transparency penalty” that disadvantages
transparent MFIs relative to their less transparent competitors
• Price may not be most important factor in determining customer’s
choice of products
Source: Drawn, in part, from Microfinance Transparency, October 2009 presentation
Developing Understandable Loan
Documentation
“These loan agreements shall further contain
such information and shall be drafted in a
manner the customers are able to
understand.”
Why is creating understandable
microcredit documentation so hard?
• Clients may be illiterate
• Even if clients are able to read language of
microcredit documentation, this may be first
contract they have ever encountered
• General lack of consumer
advocates/educators who can explain
documentation to clients and perform
watchdog role
Repayment Capacity/Debt Collection
“Furthermore, the Borrower shall critically
review the customer’s repayment capacities
before signing a loan agreement and shall
refrain from any form of unfair or even
harmful debt collection practices”
Why is determining a customer’s debt
repayment capacity so hard?
- Lack of reliable information about customer’s
credit history (lack of credit bureaus, lack of
national identification systems, etc.)
- Customers often borrow and manage finances
on a household, not individual, basis
- Most customers not ‘salaried’ so hard to
measure income levels with any reliability
Why are appropriate debt collection
practices hard to define and enforce?
• Cultural differences across regions
• MFIs likely to be assertive in pursuing defaulting borrowers for
“demonstration effect” to prevent “borrower runs” (even when
financial costs of debt collection overwhelm likely recovery)
• Lack of efficient, fair, transparent, inexpensive, accessible dispute
resolution fora can give rise to vigilante behaviors by MFIs (and/or
their agents/staff)
• Significant financial incentives imposed on MFIs by investors (and
on credit officers by MFIs) to maintain excellent repayment ratios
• Lending methodologies/technologies may rely on agents (formal
and/or informal) for debt collection/enforcement without offering
adequate guidance to or imposing effective accountability on such
agents (financial incentives may skew any guidance/accountability
that is put in place)
Just because it is hard to do is no
excuse for not doing something
What is at stake:
Reputation and health of investors in
microfinance sector
Reputation and health of microfinance sector
Livelihoods and well-being of customers of
microfinance providers
Another way to go… reframe the
question
Question: What kind of microfinance providers
do we want to encourage to operate?
If answer is:
Microfinance providers who are keenly
interested in improving the welfare of their
customers through the provision of
appropriately designed and distributed
financial services and products
Then ….
Another approach to embedding Consumer
Protection Principles into Cross-Border
Financings
Develop contractual provisions in financings
that require MFI to:
1) Adopt internal codes of conduct and systems
for monitoring adherence to such codes
2) Continually evaluate (and report) on the
impact (intended and unintended) of their
products and services on their target
customers
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Michigan Law – 1859-2009
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