> Posted by Nadia van de Walle, Lead, Africa Partnerships and Programs, the Smart Campaign
The Central Bank of Nigeria (CBN) is preparing to issue a Guide to Charges for Banks and Other Financial Institutions for providers in Nigeria, which sets out rules for commissions, charges, and rates on various products and services. It has shared the draft Guide on its website for a period of public review and commentary.
As a campaign that seeks to keep the client at the center, the Smart Campaign is always happy to see provisions in such financial sector guidelines or regulations related to thoughtful transparency and disclosure requirements. We are, however, more cautious when it comes to mandated pricing limits, given the unexpected implications we have seen them bring for clients’ lives. We notice that the CBN file introduces monthly interest rate caps.
This is at odds with the suggested policies in the Model Legal Framework for Financial Consumer Protection, which is based on the Campaign’s seven client protection principles. The Framework’s section on pricing procedures advises supervisory authorities to not set price or interest rate ceilings or floors, but rather to seek long-term solutions related to improving disclosures and facilitating market competition.
The Central Bank of Nigeria is certainly not alone in considering such caps. Interest rate ceilings are typically introduced as a government response to concerns about predatory lending, when consumers are struggling to afford high-priced loans, and particularly in markets where disclosure and transparency are poor and financial literacy is low. In Africa alone, at least twenty other countries have at one point or another introduced caps, including the Bank of Zambia in January 2013 (on effective interest rates charged by NBFIs) and the West Africa Economic and Monetary Union (which recently lowered the interest rate ceiling by 3 percent).
While well-intentioned, such caps have not been proven to help customers and in some cases could do more harm than good to their financial lives and level of service access. The first problem is lack of transparency. In an attempt to cover costs, sometimes institutions opt not to comply with these ceilings and instead mask their true prices with fees. Too-low caps may cause institutions’ growth to slow. Further, as summarized in a recent CGAP brief, such caps could distort the market and prevent financial institutions from offering loans to customers near the base of the economic pyramid who have no alternative access to credit. Evidence suggests that with caps, FIs face alternatives such as withdrawing from the market, reducing their work in rural and other costly markets, increasing their loan sizes, and going up market. In sum, efforts to cap the cost of credit end up reducing access to credit.
When stringent caps have been tried elsewhere, there have been negative results including dropout of small MFIs, flat or negative portfolio growth, and the movement of poor clients to informal, dangerous markets. When Ecuador introduced caps in 2007 and again in 2010, MFIs went up market in reaction. India in 2011 enacted a margin cap, which led to slower borrowing and lower formal financial access. Based on the Campaign’s own market experiences, we suspect that many Nigerian institutions would not be able to meet these regulatory standards and may similarly exit the market.
Thinking through these measures is particularly relevant in the African region, which has been found to have extremely high operating expense ratios and pricing, and often suffers from missing or poorly functioning credit bureaus (e.g. see research from MFTransparency on Uganda and Ghana and from the Smart Campaign on Uganda and Benin). When such ceilings have been tried before in Africa, it has been found that low income populations’ access to microfinance is lowered, transparency falls, and equity impact investors leave.
These are hard questions without easy answers. The Campaign continues to explore and advocate for alternative measures regulators and supervisors could consider to improve the health of the sector and protect clients.
We suggest focusing on transparency, including the publishing and advertising of lending rates, creating credit bureaus with mandatory financial institution participation, supporting product innovation that improves cost-efficiency, consumer protection supervision, investments in financial literacy, and consumer awareness/empowerment efforts.
The Model Legal Framework suggests considering guidelines on product risk management, and affordability and suitability assessments. Others, such as DFID, remind regulators to “let the market determine the interest rate,” by promoting competition, which compels lenders to increase efficiency and reduce costs and profit margins. In an IDB survey of financial institution managers in Latin America and the Caribbean, competition was cited as the largest factor determining the interest rate they charged. The macro evidence supports this view. Latin American countries with the most competitive microfinance industries, such as Bolivia and Peru, generally have the lowest interest rates.
There is evidence that market competition can cause interest rates in Africa to decline, despite increasing financial expenses, credit losses, and inflation. Further, in addition to ethical concerns, some studies indicate that usurious lending practices are not commercially sustainable due to demand elasticity, so the government does not need to prioritize capping interest rates, as they will fall on their own over time.
The Guidelines in Nigeria may be modified to account for such pricing cap findings or stakeholder push-back. Regardless, the weight of experience and research reminds us once again of the importance in considering the implications of well-intentioned rules on clients.
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Image credit: Accion
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