Transparent Pricing in Microfinance Implementing Transparency in the Indian Microfinance Industry MicroFinance Transparency Sa-Dhan Conference Delhi, India March 2010

OptionAmountTermInterestMethod Upfront Fees Upfront Savings Savings Interest Total Cost Option 1 $1,000 6 months 3% declining 2%0% $125 Option 2 $1,000 4 months 2% flat 2%0% $94 Option 3 $1,000 4 months 3% declining 0%20%5%$56 Option 4 All loans have the same APR. Which loan has the lowest price?

Option Amount Term Interest Method Upfron t Fees Upfront Savings Savings Interest Total Cost APR Poll Results Option 1 $1,000 6 months 3% declining 2%0% $125 43% 22% Option 2 $1,000 4 months 2% flat 2%0% $94 57% 16% Option 3 $1,000 4 months 3% declining 0%20%5%$56 54% 50% Option 4 All loans have the same APR. 12% Interest Rate Quiz - Answers

Agenda The Context – The need for pricing transparency globally MFTransparency – How MFTransparency facilitates pricing transparency in microfinance India pricing transparency – Implementation plan

The Role of Transparency in the Health of an Industry MFIs sell products Products have prices Micro-credit prices are extremely confusing If buyers don’t know true prices, the market doesn’t work If buyers get abused, microfinance becomes a tarnished industry Transparent pricing protects the poor and protects the microfinance industry

The Good News in October 2006

… the bad press began a year later

… and continues to be skeptical

And extends now to efforts to restrain Profiteering Nicaragua sets interest rates by law

Moneylenders From 1000 BC - Present “Credit Usury” NGO “projects” 1970’s – 1980’s Credit-and-training Very low interest Double-Bottom Line MFIs 1990’s- 2000’s Sustainable Credit-led Moderate interest Double-bottom line Single-bottom Line? The temptation Maximize interest? Maximize profit? What is the public reaction? Transformation begins….While supply doesn’t meet demand…. Financial Services for the Poor 3000 Years on One Slide

The Poor and Credit The poor have always had access to credit… for a price! Microfinance was born to provide a low-cost alternative to the moneylenders Ironically, we have unintentionally created a confusing environment where nobody knows the true price of microcredit products Non-transparent pricing creates a major market imperfection, impeding competition and consumer choice

Four Key Points on Pricing Transparency Interest rates vary significantly relative to loan size, making transparency difficult We operate in an industry where non-transparent pricing is common Non-transparent pricing creates a serious market imperfection, resulting in poor choices by consumers and generating the potential for high profits from lending to the poor Pricing transparency is essential to well-functioning markets, promoting efficiency, healthy competition, and better prices for millions of poor people

Four Key Points on Pricing Transparency Interest rates vary significantly relative to loan size, making transparency difficult We operate in an industry where non-transparent pricing is common Non-transparent pricing creates a serious market imperfection, resulting in poor choices by consumers and generating the potential for high profits from lending to the poor Pricing transparency is essential to well-functioning markets, promoting efficiency, healthy competition, and better prices for millions of poor people

A Fundamental Issue: Costs are relatively flat… Whereas Income is directly proportional

Costs are relatively flat relative to loan size. It costs nearly as much to make a $100 loan as a $1000 loan.

Income is generated as a percentage of the loan amount and therefore highly correlated to loan size.

For a given interest rate, there is a point where income from a single loan will be equal to the costs of that loan. This is the “breakeven point”.

Loans larger than this amount will generate profit.

Loans lower will generate financial loss.

If an institution wants to deliver smaller loans at the same interest rate, they will lose money. What must they do if they want to make these smaller loans financially sustainable?

They need to raise the interest rate, say from 30% to 40%.

As the loan size decreases, the interest rate must continue to increase in order to have a viable loan product..

Higher costs for smaller loan amounts require significantly higher interest rates for sustainability We can create a graph correlating loan size to financially sustainable interest rates and it forms a distinct curve. (Note that figures and interest rates in this curve serve only as examples and are not figures specific to the microfinance industry.)

Data for the Philippines shows a curve very close to our theoretical curve. And notice the Operating Cost Ratio range.

Common industry benchmark of 15-20% OpCost Ratio is appropriate for larger loans

But smaller loans generate an Op Cost Ratio well in excess of 20%

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30 The answer should be obvious: Transparent pricing is the right thing to do! The irony is that informed decisions and fair competition require a “market price”…. … and without transparent pricing there is no market price! Why should the industry advocate pricing transparency?

31 Why should the industry advocate pricing transparency? Another answer: MFIs benefit from transparent pricing “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

32 Why should the industry advocate pricing transparency? “There are a lot of challenges that foundations/ supporters face when looking at MFIs and trying to determine if they are efficient and pro- poor.” Transparency is a must and somewhat expected. “Instead, it is more about being accurate and consistent in the same market. Many MFIs say they charge market rates but it is very difficult to validate that statement. ” --SW, Whole Foods Foundation

33 The challenge is how to practice transparency in an environment where non-transparency is the norm… It is very difficult to be the first or only MFI practicing transparent pricing! MFTransparency will act as a neutral party to create the proper “enabling environment” Enable industry-supported “truth-in-lending” Publish APR-equivalent interest rates all-at-once, country-by-country Educate the public on why interest rates vary by loan size How can the industry advocate pricing transparency?

The Role of MF Transparency in facilitating transparent pricing 34

35 MFT Launched at the Microcredit Summit in Bali July 2008

36 Who will monitor MFTransparency Info? “MFTransparency aims at giving MFIs information to offer better value to customers. And it will give investors and others the information they need to put pressure on those institutions that may be charging unreasonably high fees or hiding the full cost of their services. We applaud the effort.” Elizabeth Littlefield, CEO, CGAP

37 Endorsers represent: MFIs Industry Supporters Independents MFI Networks & Associations MFI coverage: 30,071,792 23% Apex coverage: 49,800,000 37% Total 79,871,792 60% of total clients in the world Total world clients: 133,000,000 counted by Microcredit Summit Sponsors & Endorsers

38 MFIs Networks, Associations, Industry Initiatives, Rating Agencies Regulators, Supervisory Bodies, Consumer Protection Agencies Donors & Investo rs MFT MFT Works with all Industry Stakeholders

39 1.Collect and Publish Accurate, Transparent Pricing Data 2.Consulting on Legislation & Regulation 3.Technical Assistance & Training to Service Providers 4.Consumer awareness, “financial literacy” materials How to achieve Responsible Finance? MFT’s Business Model

Transparency for a Healthy Microfinance Industry Pricing DataEducation Policy / Regulation Website Analytical Publications Conferences and Educational Materials Effective policy requires building a strong foundation at the Bottom of the Pyramid -- Pricing Transparency and education of all stakeholders creates an enabling environment for a healthy microfinance industry Transparency Regulators 75 Countries MFI Industry 5,000 MFIs Public and Press Consumers 100 million

41 Country selection Data collection preparation Meetings with market stakeholders Training workshops in country Data Collection Work with MFIs one- on-one, if needed Data verification Data analysis & synthesis Disseminatio n of pricing data How does MFT work?

42 Methodology tested in Peru and Bosnia in March 2009 Of the MFIs that attended the training sessions: – 13/14 Bosnian MFIs submitted data (93%)* – 35/43 Peruvian MFIs submitted data (81%) Data will be shared internally, then disseminated worldwide Report with pricing analysis to follow *14 th MFI changing loan products but has committed to submitting data in June 2009 CGAP Funded Pilot Project

43 MFIs lowering prices for products priced high relative to the market MFIs increasing their prices for products priced low relative to the market Progress by regulators toward new pro-poor policies Immediate Effects of the Transparent Pricing Initiative

Countries Covered in 2009 Peru and Bosnia complete in July 2009 Cambodia and Bangladesh complete in August 2009 Azerbaijan complete in March 2010 Kenya complete in April 2010 India, Bolivia, and Ecuador to be started in April

2010 Implementation Plan Latin AmericaWest AfricaEast/Southern AfricaAsia BoliviaBurkina FasoMalawiIndia EcuadorSenegalUgandaPhilippines ColombiaIvory CoastRwandaNepal ArgentinaTogoGhana MaliSouth Africa BeninZambia Guinea BissauTanzania NigerEthiopia Mozambique 45

ADD INDIA ENDORSERS LIST 46

Endorse MFT 47 We invite all to sign our endorsement statement, committing to transparency in pricing and education of MF stakeholders

How data is presented on the MFTransparency website 48

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64 Now is the time for transparent pricing in the Indian microfinance market. One of the fastest growing microfinance markets in the world Strong regulation in place for consumer protection Increasing interest from commercial investors Networks with a strong commitment to consumer protection and responsible finance

Promoting Transparent Pricing in the Microfinance Industry 65

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Participation Rewards 67

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What would happen if an Interest Rate Cap were passed?

These loan products would disappear….

While these loan products at above market rates, would remain.

Price differential on larger loans leads to much higher profits

Objectives 1. Understand why pricing transparency is important for microfinance 2. Understand why pricing transparency is important for your financial institution 3. Learn how we can implement transparent pricing in the Indian microfinance industry 4. Prepare your institution for participation in MFTransparency’s Transparent Pricing Initiative