Putting a Microscope on Client Protection in Microfinance

> Posted by Vanesa Sanchez, Senior Analyst, Economist Intelligence Unit

The Economist Intelligence Unit’s 2012 “Microscope on Microfinance” benchmarking study – the sixth of the EIU’s annual microfinance markets assessments – features new indicators on responsible finance and client protection that cover two of the seven Smart Campaign Client Protection Principles. Transparency in pricing looks at the laws, regulations, and practices in place for interest-rate transparency among MFIs. And Dispute resolution evaluates whether a country has mechanisms for the timely resolution of disagreements, at a reasonable cost, between microfinance lenders and borrowers. These indicators were incorporated to recognize the growing importance of client protection and financial responsibility for the sustainable growth of the microfinance industry.

An empirical analysis of the Microscope by the World Bank’s research department found that after controlling for other potentially influencing factors, both of these indicators were positively correlated with market penetration measures, for example microcredit borrowers as a percentage of the country’s population or of the poor population. These indicators also correlate positively with the average loan portfolio size of MFIs at the country level. In other words, larger and more developed microfinance markets are also more likely to have consumer protections in place.

Another Microscope indicator, Regulatory capacity, examines the ability of regulators to produce sensible legal frameworks for the sector and adequately monitor institutions. This indicator also shows strong links with the penetration and loan size indicators listed above, suggesting that regulatory know-how goes hand-in-hand with well-developed MFIs.

Globally, however, much work remains to be done on client protection. According to the 2012 Microscope, a majority of countries score either 25 or 50 points out of a total possible 100 for both dispute resolution and pricing transparency.

For dispute resolution, this means countries tend to have some sort of mechanism on paper, but their accessibility and implementation are limited or non-existent. No country out of the 55 that were examined in the study received a perfect score, suggesting a need for new solutions to encourage the appropriate design of dispute resolution mechanisms for microfinance. For pricing transparency, the signs are more encouraging: Four countries in the study received a perfect score. In these countries, regulations require the disclosure of interest rates and fees by regulated and non-regulated institutions. What’s more, regulations are actually followed in practice by the MFIs that they are intended to govern. However, as with the dispute resolution indicator, a majority of countries again score 25 or 50 points out of the possible 100. Enforcement and compliance in this area remain the key sticking points. The good news is that despite the low performance on a global level, more countries during the last year improved their dispute resolution or pricing transparency than underwent deterioration. A majority of countries have, however, experienced no significant change.

Despite the existence of strong relationships, a more definitive, causal relationship between credit penetration and client protection or regulatory capacity has not yet been identified. This may be possible later on with a larger data set and further analysis. For now, it is still early stages, and the evidence found in this year’s study is encouraging. The “Microscope on Microfinance” series provides a valuable tool tracking country progress on key issues related to client protection, industry growth, and regulations for microfinance.

To access the complete Microscope findings, as well as its associated model, please visit www.eiu.com/microscope2012.

Image credit: EIU

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