Responsible Lending: A New Industry Benchmark? (John Conroy)

From left: William Tucker, P.N. Vasudevan, Royston Braganza, John Conroy

Microfinance Focus, October 15, 2010 (Colombo) : The assumption that microfinance is contributing to poverty alleviation and is benefiting the households of poor clients, predominantly women, has come under increasing scrutiny in recent years, internationally and in Asia. This is difficult topic for the industry to address; nevertheless, several industry leaders are working toward negotiating a consensus amongst the industry as to what responsible lending/pricing means. Interest rate caps are often an anathema to the industry, but the first choice of regulators seeking to protect their constituents.

How then does the industry respond? Is self-regulation an industry consensus on what is a responsible way forward? Is return on equity policies, comparative transparency or stronger promotion of competition better attractions? This session will tackle some of the most important questions facing the industry.

William Tucker, Executive Director of SEEP Network, began the session in a interactive and informal manner before introducing the three panel speakers. He said, “This is an open debate if you will. Before we start, I would like to ask for a raise of hands if anyone has an opinion about microfinance and interest rates.”

*many hands raised including panel speakers*

Who here can express his opinions or question in about 15-20 seconds?

*laughter*

Comment from the audience: I think interest rates should not be more than 25-30% because clients have to deal with other problems like inflation as well.

Comment from the audience: I would say that inefficiency in MFIs should not be passed on to consumers.

William: Aah i see, MFI operation inefficiency should not be hid by higher interest rates.

Comment from the audience: Interest rates should decline when return of equity (ROE) goes up.

William: I see there are many people with opinions in this room. Now let’s pass on to our first speaker, John Conroy.

John Conroy, Special Consultant of FDC, began his speech candidly, “How many of you remember the movie called ‘Invasion of the Body Snatchers’. I don’t know why it comes into mind when we talk about responsible lending. Sin came into the world with the invasion of consumerism.  Firstly, why the bias in this question of responsible lending – when we talk about interest rates, is it all about lending? Why is it important to bring interest rates down for loans, when it is just as important to bring interest rates up in terms of deposits? Microfinance (MF) is not all about lending. We have forgotten about the other rule of MF – deposit taking. There is new evidence that the price elasticity of interest rates on the demand for credit is high for the poor. The clients are more sensitive to interest rates than we think. So increasing interest rates leaves the poor behind. It becomes a financial excluder. I tend to put emphasis on negotiating consensus with Smart Campaign, where there is emphasis on pricing/interest rate transparency. However, some may favour more direct actions from the government to control interest rates, such as suasion, regulation or even intervention.

Methods of regulation include:

1. Creating interest rate caps – A good idea, not very novel, but why hasn’t everyone used it? We have heard that Sri Lanka is setting an upper bound to interest rates. Politician’s first choice is to set an interest rate cap but this tends to repress lending and sustainability of MFIs and leads to clients queuing outside MFIs. It also leads to credit rationalizing which tend to lead to corruption.
2. Next, margin caps, it has a one size fits all but can be problematic as well.
3. ROE (Return on Equity) caps. This can sometimes lead to non-price competition, and at the same time increase expenses of staff to reach that cap. ROE cap can be reached. Executive salary can be high, the board can have their quarterly meetings in Maldives etc *laughter from the audience*

William: Sorry to interrupt. Will everyone just bookmark this comment. Excuse me, here we have the author of a book on ‘return of equity caps’.

John: Thanks for the corporate advertising there. *audience laughter* Most suggestions and materials in microfinance are bland. Most microfinance literature give little guidance to action and are quite anodyne – such as statements like government should encourage competition. But what does competition mean? Competition is not just being busy and brisk at running the business but the Absence of market power.

In economics 101, the elements of “perfect competition” include many buyers and sellers, standardized homogenous products, with no barriers to entry to the market. Customers have perfect information about market prices and complete access to information. This ties in with the topic of responsible lending and allowing consumers to make informed choices.

Perfect completion gives rise to a level playing field.

All markets are imperfect to some degree, monopoly in extreme cases. The trick is how to make markets more competitive, towards perfection. I think the Buddhist can relate to this, achieving perfection.

MFIs must make information fully available in terms of truth in lending. Industry networking should enable information diffusion and rapid adoption of improved technology by everyone for a level playing field. Avoiding concentration of power means it is important that whoever approves licensing, takeovers & mergers are also examining the implications for competition.

Lastly, MFIs should establish effective self regulation or *drumroll* where necessary give teeth to a regulatory watchdog (power and compliance to regulatory organisations)

Soon, there will be WTO (World Trade Organisation) regulation for microfinance, I am sure of that. We should also consider the impact of foreign investment on savings mobilization. Afterall, money is flying from Wallstreet to Asia, where there is high level of returns.

And remember, “Self regulation is the last resort of scoundrels”. *laughter* Self regulation has played various roles in history to help MFIs understand their responsibilities and set their standards and goals.

Speaker’s Snapshot:

Dr John Conroy is special consultant to Australia-based Foundation for Development Cooperation (FDC), and previously served as its executive director for nine years from 1991. He is co-author of several FDC monographs on microfinance, including those dealing with NGO-commercial bank linkages and the policy and regulatory environment for microfinance in Asia, as well as a study of the role of central banks in microfinance, prepared for the Asian Development Bank. FDC is the organiser of Asia Microfinance Forum 2010.

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