Rating Agencies Spot a Few Poor Practices

> Posted by Beth Rhyne
Today my hat is off to the four specialized microfinance rating agencies – Planet Rating, MicroFinanza, M-CRIL, and MicroRate –  who are part of the Smart Campaign Certification Task Force and work with it to develop the methodology for certifying financial institutions on the Client Protection Principles. The Smart Campaign staff is very grateful to the rating agencies for the commitment and cooperation they are dedicating to creating a consensus on how to certify. That cooperation will enable the first Client Protection Certifications to take place in 2012. I am truly impressed by the knowledge the raters have acquired through examining dozens and dozens of microfinance institutions.
I was particularly struck by their warnings about some of the worst practices they have seen during rating visits recently.  These are all practices that Client Protection certifiers will look out for.

  •  High-priced credit life insurance.  Some financial institutions provide mandatory credit life insurance at a premium well above what they pay to insurance companies or what it costs them to self-insure.
  • High delinquency penalties.  Taking a cue from consumer lenders, some microfinance institutions charge stiff penalty fees to clients who become delinquent. This allows institutions to prosper even when their clients are struggling.
  • Hefty prepayment penalties. When clients prepay their loans, they may still be required to pay all the interest owed through the remainder of the loan term.

Early renewals as a delinquency avoidance device.  It is okay for a lender to immediately extend a new loan to a client who has paid off a previous loan.  But if it becomes standard for this termination and renewal to take place in the early or middle stage of a loan, it may signal that new loans are covering for the risk of default of old ones.
While I am confident that such practices are relatively rare, it is troubling to hear about them.
All these poor practices have this in common:  They allow financial institutions to increase their income or their apparent portfolio quality in ways that are not obvious and not part of the basic interest rate. When competition is intense and focused on interest rates, it is not surprising that providers might seek indirect solutions like these.  Some of these practices may be helped by another factor – the frequent lack of plain language contracts that clients can understand.
Practices like this will inevitably creep into microfinance if the leaders and participants in the sector fail to be vigilant. Thanks to the experience of the specialized microfinance rating agencies, we can be alert to poor practices like this and call attention to them, possibly before they spread.
Image credit: Batholith
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