How does Consumer Protection Relate to Microcredit?
Compiled by Deborah Burand
The microfinance industry is becoming more customer-oriented in its delivery and design of financial products and services. And, in some markets, a growing array of players now competes to provide financial services and products to the poor and the un-banked. Accordingly, it is not surprising that the voice of the microentrepreneur is growing louder and more insistent on asserting her or his rights as a consumer of financial products and services.
For consumers of microcredit (the borrowers), these rights tend to fall into two distinct and separate areas:
- Advancing truth-in-lending practices, and
- Protecting against abusive lending and debt collection practices
| As the range of financial products and services offered to the poor and un-banked grows and the number and diversity of providers of these services also increase, it is likely that concerns about consumer protection as it relates to microfinance will only intensify and expand to address issues relevant to the marketing and sale of an array of financial products and services that goes far beyond the sale, delivery, and collection of microcredit. For example, consumer protection issues may arise in connection with the development and delivery of remittance services, insurance products, and savings products to the poor and un-banked. |
This highlight explores the goals of consumer protection as applied to microcredit, discusses how consumer protection regulation is being implemented where microcredit is concerned, and provides additional resources for further reading.
What are the General Goals of Consumer Protection Regulation as Applied to Microcredit?
Truth-in-lending: With respect to the marketing and sale of microcredits, the goals of consumer protection tend to cluster around questions of transparency or "truth-in-lending" practices aimed at ensuring the consumer understands (and is capable of understanding) the terms of the loans she or he might receive. Truth-in-lending practices typically provide borrowers with accurate, comparable and transparent information about the cost of loans.
In some countries, notably the United States, there is a growing concern, however, that quantity of information is no substitute for quality of information when it comes to truth-in-lending practices. In short, simply giving more information to the consumer may not promote greater consumer protection.
Others have cautioned that if truth-in-lending requirements are not applied evenly in a market to all providers of financial services, then those providers subjected to a lesser standard of transparency may operate at an unfair advantage to those that are meeting a higher standard of transparency in their dealings with customers.
Abusive or inappropriate lending and debt collection practices: With respect to the delivery and collection of microcredits, the goals of consumer protection tend to focus on ensuring that the microfinance lender (or its agent) treats its customers fairly and with appropriate regard for the customers' dignity and welfare, thus avoiding any abusive or otherwise inappropriate lending or debt collection practices. This is easier said than done, however.
The range of appropriate lending and debt collection practices is certain to be shaped by the culture and mores where the microfinance provider operates, as well as the products and delivery systems used by the microfinance provider (actions taken to collect a small group loan that enjoys a group guarantee may be very different from what constitutes appropriate actions to collect a collateralized loan to an individual). The sophistication and education levels of the target clientele also may shape what is "appropriate" behavior by a microfinance provider.
Finally, the appropriateness of debt collection practices will be shaped by the dispute resolution alternatives available in that market. For example, where courts are slow, corrupt, or otherwise not reliable, self-help collection methods by microfinance providers may be necessary. The challenge then becomes determining what kinds of "self-help" are appropriate for the microfinance provider to undertake directly or indirectly.
How is Consumer Protection Regulation being Implemented?
- Who is being regulated?
- How formal is the regulation and who is the regulator?
- What kind of activity is being regulated?
While consumer protection is not usually considered to be a matter warranting "prudential regulation" by bank regulators, consumer protection regulation often is informed by a risk-based analysis, not unlike that applied to risk-based bank supervision. Accordingly, the scope and reach of consumer protection regulation will vary as policymakers seek to balance the nature of the perceived harm or risk to the consumer against the regulatory compliance cost to the provider of the financial services and products in question. So it should come as no surprise that consumer protection regulation as applied to financial services, of which microfinance is a part, takes many forms from jurisdiction to jurisdiction. It varies as to:
- the range of institutions and activities to which consumer protection regulation applies,
- the formality (or not) of such regulation and the authority charged with enforcement, and
- the content and scope of consumer protection regulation.
It is not unusual for formal providers of microfinance, such as commercial banks, specialized microfinance banks and deposit-taking microfinance institutions, to be subjected to some form of consumer protection regulation--focusing on truth-in-lending practices, abusive loan and debt collection practices, or both. However, consumer protection regulation does not always stop there.
Less formal providers of microfinance, including not-for-profit, credit-only institutions also are coming under scrutiny by some regulators. In those cases, the focus to date generally (but not always) has been on truth-in-lending focused regulation such as requiring microfinance providers to post publicly information about the financial terms of their loans.
How Formal is the Regulation and Who is the Regulator?
To date, most "formal" consumer protection regulation aimed specifically at microfinance is being overseen by a bank regulatory agency or a government agency that is closely aligned with the bank regulatory agency.
| One notable exception to this generalization, however, is South Africa. In 1999, a more self-regulatory approach was taken with the establishment of the South African Micro-Finance Regulatory Council (MFRC) whose Board was composed of both microfinance industry representatives and consumers. The purpose of the MFRC was to supervise the operations of institutions lending under an exemption from the Usury Act. With the recent adoption of financial sector reforms in South Africa, however, the MFRC will be replaced by a National Credit Regulator (NCR) that has the power to regulate nearly all loans made to natural persons. (See Meagher 2005) |
Informal regulation also can play an important role in responding to consumer protection concerns. Where consumer protection regulation is informal, some groups of microfinance providers are developing forms of self-regulation that aim to establish standards for consumer protection practices and, in a few cases, even provide for surveillance and enforcement mechanisms.
Association of Microfinance Institutions in Timor-Leste (AMFITIL)
One example of self-regulation is the microfinance network of East Timor (Association of Microfinance Institutions in Timor-Leste - AMFITIL) that established a code of conduct in April of 2004 for its members that establishes best practices and standards for institutions providing microfinance services in Timor-Leste. Article 12 of the AMFITIL Code of Conduct expressly provides that by signing this code, members of the AMFITIL undertake to hold themselves accountable to the principles and practices therein. The Code goes farther still, however, and provides that should a member fail to comply with those principles and practices, the association's leadership can exclude that member from the association after giving the member an opportunity to speak in its defense. (See "AMFITIL Code of Conduct for Members".)
MicroFinance Network (MFN) Pro-Consumer Pledge
A different approach was taken by the microfinance providers who have agreed to adhere to the MicroFinance Network's Pro Consumer Pledge. This Pledge expressly acknowledges that the consumer protection principles it champions may put observant microfinance providers at a disadvantage to "less conscientious" organizations. To minimize this disadvantage, the Pledge suggests that collective action--either by the industry or regulatory authorities--may be necessary to enforce application of these principles. (See Microfinance Network Pro-Consumer Pledge).
Freedom from Hunger Statement on Ethical Treatment of Clients
Still another self-regulatory approach has been taken by Freedom from Hunger. Its "Statement on Ethical Treatment of Clients" was approved by the Trustees of Freedom from Hunger in June 2004. This Statement focuses on setting standards for how clients should be treated by Freedom from Hunger and its local partners. The Statement does not address enforceability.
What Kind of Activity is being Regulated?
Some analysts have divided consumer protection regulation of microcredit according to the stages in the lending cycle--before sale, at time of sale, and after sale. (See Porteous and Helms 2005.)
» Before sale: Some regulators have required that all charges be declared and that interest rates be stated in such a standardized way as to allow for meaningful comparisons across microfinance providers.
For example, draft regulations in Zambia require microfinance institutions to display publicly in their places of business a statement that describes, among other things, the financial product being offered, the terms under which the product is being offered, and customers rights and responsibilities. (See Zambia's Draft Microfinance Regulations 2003, Section 36).
In Kazakhstan, a microlending organization must place a copy of its approved general procedures in a public place. And microlending organizations are required to inform borrowers, prior to the making of a loan, about all costs related to obtaining and servicing a loan. They also are required to inform borrowers of their rights and responsibilities before getting microcredit. (See Law of the Republic of Kazakhstan on Microlending Organizations).
Those developing self-regulatory regimes to respond to consumer protection concerns also often address this topic to ensure that clients receive complete and understandable information about the true costs of the services clients are receiving. (See Microfinance Network Pro-Consumer Pledge, Principle 2).
» At time of sale: Some regulators have proscribed some of the contents required in the documentation manifesting the microcredit. For example in Tanzania, regulators require the underlying loan documentation to state the nominal rate of interest as well as all commissions and fees. The documentation must also allow borrowers to prepay in part or in whole their microcredits. And, if prepayment penalties are to be charged, then rate of penalty also must be described in the loan documentation. (See Tanzania's Microfinance Companies and Microcredit Activities 2004, Section 27)
As a matter of self-regulation, non-regulated members of the Microfinance Working Group of the ETAMFI have addressed in detail the topic of how to manage the compulsory savings of microcredit borrowers who pledge such savings as partial security against default. The Code of Conduct highlights the responsibility of members to safeguard clients' savings deposits against moral hazard and related risks and establishes standards for how to collect and hold any such savings. (See AMFITIL Code of Conduct for Members, Art. VII – Financial Management)
» After sale: Some regulators have started to pay more attention to the "after sale" actions and relationships between borrowers of microcredits and their lenders. This can range from debt collection practices to how and when information is shared with third parties about the credit histories of microcredit borrowers. vOne area that the Tanzania government is focusing on is the nature of the debt collection practices being implemented by the microfinance provider. The Central Bank of Tanzania has been authorized to monitor the debt collection practices of institutions engaged in microcredit and may order the discontinuation of any practice that it deems "abusive". (See Tanzania's Microfinance Companies and Microcredit Activities 2004, Section 27)
Regulators in Kazakhstan have focused on issues of bank secrecy, thereby narrowly limiting by law the institutions that can learn information about borrowers of microcredits without first obtaining the borrower's consent. (See Law of the Republic of Kazakhstan on Microlending Organizations, Art. 16)
Management of consumer complaints during entire lending cycle
Other regulators, notably Bolivia, are paying more attention to how providers of microfinance are managing consumer complaints throughout the lending cycle. Bolivian regulators have created an Attention of Clients' Claims Services (SARC). The SARC requires financial institutions to answer client claims within five days or to take their claim directly to the SARC. If a claim is not responded to by the applicable financial institutions within five days, then the claim is passed to the Superintendency of Banks and Financial Institutions to be addressed. This allows the Superintendency to take preventive and corrective actions while promoting transparency in customer relations. (See Resolución SB N° 007/2001 of Jan. 29, 2001, as amended [pdf, in Spanish].
The MFN Pro-Consumer Pledge also addresses this issue as a matter of self-regulation. It provides that members adopting the MFN Pro-Consumer Pledge will provide formal feedback channels of communication for clients about the quality of service quality. Members have agreed also to ensure that such channels will include mechanisms for responding to specific complaints. (See Microfinance Network Pro-Consumer Pledge Principle 8).