1. Transparent Pricing Progress: Now to Understand the Prices We Charge
Promoting Transparent Pricing in the Microfinance Industry
Transparent Pricing Progress:
Now to Understand the Prices We Charge
SPTF Webinar
January 2013
Cover slide

2. Agenda Introduction to the confusing world of micro-credit pricing
Averages are deceptive in microfinance!
To understand microfinance, you need to understand “the curve”
Transparent pricing is necessary to make the flawed market of micro-credit function better

3. How did microfinance end up with non-transparent pricing?

4. Which loan would you pick?
Zero Interest Loan
Interest and Fees
And Savings
Interest Only
Loan amount:
$1,000
Loan term:
10 weeks
Interest Rate: 0%
15% “flat”
12% “flat”
40% decl
Upfront fee: 5% 2% 1%
Security deposit:
20%
Our pricing is not transparent. Moving toward standardized truth-in-lending indicators helps all stakeholders understand product pricing

5. Which loan would you pick?
Zero Interest Loan
Interest and Fees
And Savings
Interest Only
Loan amount:
$1,000
Loan term:
10 weeks
Interest Rate: 0%
15% “flat”
12% “flat”
40% decl
Upfront fee: 5% 2% 1%
Security deposit:
20%
TCC
$50
$33
$42
Our pricing is not transparent. Moving toward standardized truth-in-lending indicators helps all stakeholders understand product pricing

6. Which loan would you pick?
Zero Interest Loan
Interest and Fees
And Savings
Interest Only
Loan amount:
$1,000
Loan term:
10 weeks
Interest Rate: 0%
15% “flat”
12% “flat”
40% decl
Upfront fee: 5% 2% 1%
Security deposit:
20%
TCC
$50
$33
$42
APR
49%
47%
40%
Our pricing is not transparent. Moving toward standardized truth-in-lending indicators helps all stakeholders understand product pricing

7. Which loan would you pick?
Zero Interest Loan
Interest and Fees
And Savings
Interest Only
Loan amount:
$1,000
Loan term:
10 weeks
Interest Rate: 0%
15% “flat”
12% “flat”
40% decl
Upfront fee: 5% 2% 1%
Security deposit:
20%
TCC
$50
$33
$42
APR
49%
47%
40%
Our pricing is not transparent. Moving toward standardized truth-in-lending indicators helps all stakeholders understand product pricing
Transparency
Index 32 25
100

8. Which loan would you pick?
Zero Interest Loan
Interest and Fees
And Savings
Interest Only
Loan amount:
$1,000
Loan term:
10 weeks
Interest Rate: 0%
15% “flat”
12% “flat”
40% decl
Upfront fee: 5% 2% 1%
Security deposit:
20%
Nominal Annual Interest Rate
Full APR
Full Transparency = 100
TCC
$50
$33
$42
APR
49%
47%
40%
Our pricing is not transparent. Moving toward standardized truth-in-lending indicators helps all stakeholders understand product pricing
Transparency
Index 32 25
100

9. The Downward Spiral
How did prices get so confusing and non- transparent?
It is a combination of:
Lack of transparent pricing regulation
Initial motivation of a small minority to mask the true price
The result is a downward spiral drawing in nearly all MFIs

10. The Downward Spiral MFI 1: MFI 2: All MFIs have transparent prices
Interest: 2.5% decl.
MFI 2:
Interest: 3.0% decl.

11. The Downward Spiral MFI 1: MFI 2: All MFIs have transparent prices
Some MFIs shift to flat interest
MFI 1:
Interest: 2.5% decl.
MFI 2:
Interest: 2.0% flat

12. The Downward Spiral MFI 1: MFI 2: All MFIs have transparent prices
Some MFIs shift to flat interest
All MFIs shift to non- transparent pricing
MFI 1:
Interest: 1.75% flat
MFI 2:
Interest: 2.0% flat

13. The Downward Spiral MFI 1: MFI 2: All MFIs have transparent prices
Some MFIs shift to flat interest
All MFIs shift to non- transparent pricing.. And it continues
MFI 1:
Interest: 1.75% flat
MFI 2:
Interest: 1.6% flat, 2% upfront fee

14. The Downward Spiral MFI 1: MFI 2: All MFIs have transparent prices
Some MFIs shift to flat interest
All MFIs shift to non- transparent pricing
Consumers struggle to choose…. Which would YOU choose?
MFI 1:
Interest: 1.75% flat
MFI 2:
Interest: 1.6% flat, 2% upfront fee

15. The Downward Spiral MFI 1: MFI 2: All MFIs have transparent prices
Some MFIs shift to flat interest
All MFIs shift to non- transparent pricing
Consumers struggle to choose… Because the prices are far from clear
MFI 1:
Interest: 1.75% flat
APR: 37%
MFI 2:
Interest: 1.6% flat, 2% upfront fee
APR: 57%

16. The Downward Spiral MFI 1: MFI 2:
All MFIs have transparent prices
Some MFIs shift to flat interest
All MFIs shift to non- transparent pricing
Consumers struggle to choose
Profits are correlated to price when loans are identical
MFI 1:
Interest: 1.75% flat
APR: 37%
ROE: 10%
MFI 2:
Interest: 1.6% flat, 2% upfront fee
APR: 57%
ROE: 40%

17. The Downward Spiral Prices are far from clear, and thus:
Consumers over-consume
Market competition is hindered
Strong temptation from high profits
The poor are harmed
Public image is tarnished
Governments urged to intervene
Transparency, and particularly pricing transparency, is a key element to correct this serious problem in the microfinance industry

18. Two common questions without simple answers: 1) What is the “market price” of microcredit? 2) What is a “responsible price” for microcredit?

21. Average Price

22. Responsible Pricing Range

23. Too High!
Responsible Pricing Range
Too Low!

29. Is there a curve in other countries?

35. The interesting question:
Are institutions “off-of-the-curve” pricing responsibly?

36. Why is there a price curve for micro-loans?

37. Cost Components that Affect Pricing
Financial Costs
10%
Loan Loss 2%
Operating Costs
20%
Profit 3%
Total Price
35%

38. Realizing that there is a Cost Curve
Efficiency 1 2 3
Operating Cost per Loan
$50
Loan Size
$500
Operating Cost Ratio
10%

39. Realizing that there is a Cost Curve
Efficiency 1 2 3
Operating Cost per Loan
$50
Loan Size
$500
$250
Operating Cost Ratio
10%
20%

40. Realizing that there is a Cost Curve
Efficiency 1 2 3
Operating Cost per Loan
$50
$30
Loan Size
$500
$250
$100
Operating Cost Ratio
10%
20%
30%

41. In the Philippines, we find a curve not only for prices, but also for Operating Costs.

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

43. But smaller loans generate an Op Cost Ratio well in excess of 20%
Then stress how the ratings agencies and the judgments and opinions always say: “if your OCR is 15% you’re doing really well, and if you are 30% or 40% you are really bad and wasteful and inefficient.”
Those MFIs focusing on the very smallest loans, going to the neediest clients, are judged to be doing a bad job, to be inefficient. We don’t consider loan sizes when we make these judgments, and clearly loan size has a dramatic influence on the OCR.

47. Notice that in all three countries there is a remarkably consistent spread between OCR and Yield

48. Cost Components that Affect Pricing
Financial Costs
10%
Loan Loss 2%
Operating Costs
20%
Profit 3%
Total Price
35%
Let’s look at Bolivia

49. Financial Expenses range between 2% and 5%, with a flat-average of 3%, not correlated to loan balance.

50. Loan Provision is a consistent 1% to 2%, not correlated to loan balance.

51. Operating Cost Ratio is by far the largest component, ranging from 10% to 30% and is highly correlated to loan balance.

52. Pricing for Different Products
Component
$100 Loan
$1000 Loan
Financial Costs
10%
Loan Loss 2%
Operating Costs
50%
15%
Profit 3%
Total Price
65%
30%

53. Defining a Responsible Price
MFI’s Costs

54. Defining a Responsible Price
+ MFI’s Choice of Profit
MFI’s Costs

55. Defining a Responsible Price
= Price Set by the MFI
+ MFI’s Choice of Profit
MFI’s Costs

56. Defining a Responsible Price
What Price Can the Poor Afford?
= Price Set by the MFI
+ MFI’s Choice of Profit
MFI’s Costs

57. How should we define a “Transparent Price”. Total Cost of Credit (TCC)
How should we define a “Transparent Price”? Total Cost of Credit (TCC)? Annual Percentage Rate (APR)? Effective Interest Rate (EIR)?

58. Total Cost of Credit “Isn’t Total Cost of Credit sufficient
Total Cost of Credit “Isn’t Total Cost of Credit sufficient? It’s what clients ask for. They don’t understand abstract percentages!”

59. Which would you buy? $1 $2

60. Which would you buy? $2 $1
1 liter
3 liters

61. Prices of loans are much harder…
Prices of loans are much harder…. We aren’t buying an item, we are renting money, and we are renting a variable amount of money for a variable amount of time.

62. Which would you buy? Example 1
Loan 1
Loan 2
Amount
$1,000
Term
12 months
Total Cost
$130
$119
Ask for raised hands. How did you decide?

63. Which would you buy? Example 1
Loan 1
Loan 2
Amount
$1,000
Term
12 months
Total Cost
$130
$119
APR
24%
22%

64. Which would you buy? Example 2
Loan 1
Loan 2
Amount
$1,000
$1,500
Term
12 months
18 months
Total Cost
$179
$333
Ask for raised hands. How did you decide?

65. Which would you buy? Example 2
Loan 1
Loan 2
Amount
$1,000
$1,500
Term
12 months
18 months
Total Cost
$179
$333
APR
33%
28%

66. Now which? Example 3 Loan 1 Loan 2 Amount $2,000 $3,000 Term 6 months
Compulsory Savings
10% 0%
Total Cost
$245
$568
Ask for raised hands. How did you decide?

67. Now which? Example 3 Loan 1 Loan 2 Amount $2,000 $3,000 Term 6 months
Compulsory Savings
10% 0%
Total Cost
$245
$568
APR
50%
35%
(declining balance)

68. What is the APR? (Annual Percentage Rate) The APR indicates the cost for you to borrow $1.00 for one year. It is a unit rental cost. An APR of 30% means it would cost you 30 cents to borrow $1.00 and keep the entire $1.00 for one full year. The APR is an essential figure for you to compare the true cost of different loans.

69. Example of Loan Pricing
Interest rate of 3% per month
Small closing fee of 2%
Savings account with 15% of loan
We pay you 5% interest on your savings
What do you think the APR of this loan is?
(we will calculate APR without compounding, i.e, using the US formula, not including compounding, as with the EU formula)

70. Declining Balance interest reflects the textbook definition of interest as a charge for the use of money over time. APR is equivalent to declining balance interest with no fees.

71. With “Flat” interest, interest is charged on the original loan amount resulting in nearly double the cost of declining balance interest. Why double? The area of the rectangle under the green line is almost double the area under the red stair-step loan balance.

72. In addition, the client is often charged fees for the loan
In addition, the client is often charged fees for the loan. In this example, a 2% up-front fee, because of the short loan term, surprisingly adds 13% to the APR. A loan advertised as 36% interest is now the equivalent of 78% APR.

73. The red area shows money invested in business.
The blue line shows money held in savings.
Compulsory savings adds to the cost. Clients are charged interest on the original loan ($1000) even though they never have use of that amount. In this example, the APR is now 107%.

74. Clients are paid interest, but significantly less interest on their savings than they are charged on their loans. When earning 5% interest, the APR only drops from 107% to 105%.

75. First, it depends on what level you are analyzing
What price is a loan?
First, it depends on what level you are analyzing
Institution-Level: Global Portfolio Yield
Product-Level: Product Portfolio Yield for each product
Client-Level: The APR of that specific loan
Second, it depends on what you include in the price:
Portfolio Yield: Only interest and some fees
MFT’s “APR”:
Includes all costs the client pays in the contract (interest fees, insurance, taxes)
Also includes the hidden cost of a Compulsory Deposit

76. “The full cost of a loan must include not only interest and fees, but also Compulsory Deposits, that we often call “savings”

77. “I believe it should be what the client pays – interest and fees
“I believe it should be what the client pays – interest and fees. The Total Cost of Credit is the real cost. Savings is a benefit, not a cost.”

78. “Savings does have some perceived benefit – the client leaves with cash in their pocket. But when borrowing and saving at the same time, that savings affects the price of the loan”

79. “Let’s look at a simple example, following a loan to a client, to understand why.”

80. $1000 “Here’s a loan…. AND we help you SAVE”
(savings is a requirement of this loan)
$1000

81. Interest Rate = 2.5% per month (flat) or $25 per month
Loan Term = 10 months
Loan Amount = $1000
Compulsory deposit = 20%
Interest Rate = 2.5% per month (flat) or $25 per month
$200
$1000
$800

82. After 1 month % interest $5 $200 $20 $100 $700 % interest + principal
Part of the loan interest paid is for the part of the loan that is in “savings”
% interest $5
$200
$20
$100
$700
% interest + principal

83. After 6 months – Amounts are equal
% interest $5
$200
$20
$100
$200
% interest + principal

84. After 8 months - none of original loan left
% interest $5
$200
Loan payments are now coming out of her business assets, as all the loan that went to the business is repaid
$100 $0
$20
% interest + principal

85. So client may be forced to liquidate stock in order to repay the loan
$200
Negative $!!

86. At end of loan – savings are repaid to client
$200 $0

87. But what has client actually paid?
Using TCC – Total Cost of Credit
Interest paid on loan = $250
INTEREST
TCC = $250
Without Savings
Av. Loan Balance for
business = $550
PRINCIPAL
With Savings
Interest paid on loan = $200
Interest paid on savings = $50
Av. Loan Balance for
business = $350
INTEREST
TCC = $250
Loan repayments = $1000

88. But what has client actually paid?
Using APR – Annual Percentage Rate
Interest paid on loan = $250
INTEREST
Total APR = 51%
Without Savings
Av. Loan Balance for
business = $550
PRINCIPAL
With Savings
Interest paid on loan = $200
Interest paid on savings = $50
Av. Loan Balance for
business = $350
INTEREST
Total APR = 75%
Loan repayments = $1000

89. Now for another quiz…. Same loan amounts, same term and… same interest rate, no fees (should be easy, right?)

90. Which loan would you pick?
Loan amount:
S1,000
$1,000
Loan term:
12 months
Interest Rate:
36% p.a. “flat”
Paid upfront
Paid monthly
Grace period No
3 months grace
Theoretical example.

91. Which loan would you pick?
Loan amount:
S1,000
$1,000
Loan term:
12 months
Interest Rate:
36% p.a. “flat”
Paid upfront
Paid monthly
Grace period No
3 months grace
Total Cost Credit
$360
Theoretical example.

92. Which loan would you pick?
Loan amount:
S1,000
$1,000
Loan term:
12 months
Interest Rate:
36% p.a. “flat”
Paid upfront
Paid monthly
Grace period No
3 months grace
Total Cost Credit
$360
Theoretical example.
APR
91%
51%
61%

93. Which loan would you pick?
Loan amount:
S1,000
$1,000
Loan term:
12 months
Interest Rate:
36% p.a. “flat”
Paid upfront
Paid monthly
Grace period No
3 months grace
Total Cost Credit
$360
Theoretical example.
APR
91%
51%
61%
Transparency Index 39 71 59

94. Which loan would you pick?
Upfront interest can dramatically increase the cost because client has less money for less time
Loan 1
Loan 2
Loan 3
Loan amount:
S1,000
$1,000
Loan term:
12 months
Interest Rate:
36% p.a. “flat”
Paid upfront
Paid monthly
Grace period No
3 months grace
Total Cost Credit
$360
Theoretical example.
APR
91%
51%
61%
Transparency Index 39 71 59

95. Which loan would you pick?
Upfront interest can dramatically increase the cost because client has less money for less time
Grace periods on “flat interest” loans can significantly reduce the actual price, because client has more money for more time
Loan 1
Loan 2
Loan 3
Loan amount:
S1,000
$1,000
Loan term:
12 months
Interest Rate:
36% p.a. “flat”
Paid upfront
Paid monthly
Grace period No
3 months grace
Total Cost Credit
$360
Theoretical example.
APR
91%
51%
61%
Transparency Index 39 71 59

96. You can use our MFT Pricing Calculator to deepen your understanding and to calculate actual prices of loans

97. MFT Pricing Calculation Tool –
Advanced Analysis

98. MFT Pricing Calculation Tool –
Advanced Analysis

99. Promoting Transparent Pricing in the Microfinance Industry
Cover slide

100. Save the Date!
SPM Essentials Module 7: Social Audit and Social Rating Monday, 4 February :00 – 10:00 am EDT