Evidence on the Business Case for Client Protection

> Posted by Nadia van de Walle, Senior Africa Specialist, the Smart Campaign

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Serve clients with suitable products. Prevent over-indebtedness. Be transparent and price products reasonably. Treat clients respectfully, listen to their grievances, and protect their privacy.

The seven client protection principles make undisputedly good sense on paper. It’s hard to argue against any one of these practices, either normatively or from the perspective of the financial bottom line. We assume that well-treated, well-understood clients using appropriate products through the right delivery channels are more loyal, satisfied, and likely to refer their friends and family, provide useful feedback, and repay loans. Right?

Businesses seem to think so. The Smart Campaign has over 1,400 endorsements from institutions around the world, and many have invested in client-centered management (see the example of Fundación Mundo Mujer Popayán here). Anecdotally, institutions have described how putting the principles into practice reduced risk and successfully addressed client complaints (see here, here, and here).

But is there any empirical proof that the principles make for good business?

To date, little data has been available to test assumptions of synergy between client protection and financial performance.

However, a recent study from the European Microfinance Platform takes us a step forward in building the business case for client protection. It draws on an exceptionally large dataset (with nearly 3,000 observations) from the databases of eight sector stakeholders—investors, ratings agencies, and social performance auditors.

The data was collected between 2004 and 2011 and spans institutions in 95 countries. Data collection methods included self-reporting, on-site visits, client focus groups, and surveys. The dataset was analyzed to establish which institution items corresponded to the client protection principles. The institutions’ financial performances were based on the variables of return on equity, return on assets, operating expense ratio, and portfolio at risk (PAR) levels. Using simple correlations (data limitations prevented more sophisticated analysis), the study finds some interesting relationships. Some are intuitive, while others left me scratching my head.

More intuitive results include that good practices in transparency, collection practices, ethical staff behavior, complaints resolution, and privacy all coincide with better financial returns. If clients are informed and appropriately supported, they’re in a better position to make payments and actively use services. Good collections practices are associated with lower PAR levels and implementing complaints systems are associated with lower operational costs. On the other hand, good practices in preventing over-indebtedness, such as serious repayment capacity analysis, appropriate repayment schedules and use of collateral, and market level credit information sharing, are associated with higher operational costs.

What was less intuitive to me was the finding that transparency is associated with higher PAR. Why do you think this might be? I wondered if the counter-intuitive relationship between transparency and PAR could be partly due to the fact that more transparent institutions are also more transparent on their financial performance, which means they are less likely to underestimate or hide poor portfolio quality with write offs?

Perhaps the most surprising finding was that this study found no link between preventing over-indebtedness and portfolio quality.

We all know that a single study does not always tell the full picture. What might currently be hidden and emerge down the road? For example, it would be interesting to examine whether there is a time dimension in the returns to client protection. Perhaps early investment in some client protection aspects do not immediately pay off, but organizations with best practices in client protection ultimately achieve better financial outcomes, either from the benefits of the individual client protection practices, or thanks to the benefits of a good reputation.

A final observation on the study is that researchers did not try to say what causes what. For instance, do ethical collections practices lead to higher financial returns or is it the other way around?

Overall, it’s clear that both larger sets of quality data and further studies are needed. I hope that the microfinance sector will continue to harmonize and simplify data collection on social performance and responsible finance practices. I also hope this study, already a step in the right direction, will be followed by others.

Have you read?

The Business Case for Investing in Financial Inclusion

The Business Case for Transparent Pricing

The Smart Campaign in Laos: Microfinance Association Establishes Client Protection Framework