A decade ago, <a href="https://www.cgap.org/topics/collections/digital-credit" target="_blank" rel="noopener noreferrer">digital credit models</a> that catered to low-income consumers were relatively unknown and untested. A lot has changed since then. Data from the <a href="https://ccaf.io/" target="_blank" rel="noopener noreferrer">Cambridge Center for Alternative Finance</a> shows that between 2011 and 2021, the number of digital lenders -- including those catering to low-income consumers -- has grown nearly ten-fold globally. <a href="https://www.imf.org/en/Publications/WP/Issues/2021/03/19/Digital-Financial-Inclusion-in-Emerging-and-Developing-Economies-A-New-Index-50271" target="_blank" rel="noopener noreferrer">Economies in Africa and Asia</a> have significantly driven this growth within the emerging market context. This rapid growth has been accompanied by a rise in consumer protection challenges, which have been studied and <a href="https://www.cgap.org/topics/collections/digital-credit" target="_blank" rel="noopener noreferrer">reported extensively in the East African context</a>.  

Catalytic capital — debt, equity, guarantee, or other instruments that assume disproportionate risk to return — is often seen as an important signaling device to attract further, timely investment in the target. As such, it can facilitate innovation and help organizations and companies build a track record in underserved markets. 
<blockquote class="pullquote--right">Catalytic capital has spurred rapid growth in digital credit, but at the same time, digital credit has created significant concerns over consumer protection.</blockquote>
However, the role of catalytic capital in influencing market-level incentives for digital credit has been less studied. In multiple markets, catalytic capital has spurred rapid growth in digital credit, resulting in an influx of investment. At the same time, digital credit has created significant concerns over consumer protection, and the supervisory capacity of local regulators has failed to keep pace with the risks emerging from the rapid growth of digital credit.  

In our research, we focus on the role of catalytic capital in shaping market incentives as they attract capital to digital credit models. We conclude that the role played by catalytic capital differs depending on the stage of market development. At an early stage, catalytic capital investments can help prove business models, expand services to newer consumer segments, and/or attract capital to underserved geographies. As the supply of capital increases, markets shift to a growth stage. Catalytic capital investors, who are more impact-oriented, need to shift their roles as markets grow to one that addresses consumer risks that accompany an increased supply of capital.  
<h1>A helpful case study: Kenya -- the birthplace of digital credit  </h1>
Our research traces the role played by catalytic capital investments, mapping consumer risks that evolved to missed signals that catalytic capital investors could have used to build guardrails. We hope other markets on a similar growth path as Kenya can use this guidance. 

Consumer risks rising from digital credit can be influenced through investor incentives, and they fall into three broad categories: 
<h3>High interest rates, indebtedness, and default risks</h3>
Financial service providers often cite the high cost of funds in emerging markets as the underlying driver for high interest rates. Catalytic capital investors can play a crucial role in reducing the cost of funds by deepening domestic capital markets. As one positive example, Lendable and other funders, including FSD Africa, set up a fund offering a first-loss default guarantee. This structure mobilizes domestic debt investors, increases transparency, and reduces the cost of funds for end borrowers as the supply of on-lending funds in emerging markets becomes less constrained. 
<h3>Aggressive sales practices, exploitative terms and conditions, and deceptive fees</h3>
As investments in digital credit models rise, there is a need to establish responsible market practices. Catalytic capital providers can play a role in working with industry associations and regulators to establish responsible market practices, and advocacy is one of the most powerful tools they can use. For example, community Investment Management (CIM) is an institutional impact manager that began operations in mature markets and is now expanding to emerging markets. CIM co-founded <a href="http://www.borrowersbillofrights.org/bill-of-rights.html" target="_blank" rel="noopener noreferrer">the Small Business Borrowers’ Bill of Rights</a>, identifying six fundamental financing rights of all businesses. The Small Business Borrowers’ Bill of Rights has now been adopted by the <a href="https://www.aspeninstitute.org/programs/business-ownership-initiative/small-business-borrowers-bill-rights/#:~:text=The%20Small%20Business%20Borrowers%E2%80%99%20Bill%20of%20Rights%20identifies,in%20order%20to%20uphold%20and%20protect%20those%20rights." target="_blank" rel="noopener noreferrer">Responsible Business Lending Coalition,</a> a network of for-profit and non-profit lenders, brokers, and small business advocates. 
<h3>Data privacy issues</h3>
With the emergence of technology-driven business models, using data to innovate is a crucial part of the DNA of digital financial services. Catalytic capital providers have a role in ensuring that companies respect data privacy without constraining innovation. 
<h1>Complementing catalytic capital investments for responsible market development </h1>
While catalytic capital is crucial for innovations and expanding access, not everything is attributable to catalytic capital investors. While catalytic capital may enable market development, as the case of digital credit demonstrates, responsible market development does not automatically follow. Several other factors must be supported to complement investor incentives for responsible market development. Responsible market development needs investments beyond the firm level to enable market information, consumer awareness and capability, regulatory and supervisory capacity, and various other measures that can serve as checks and balances on firm behavior.  

While investors can conduct firm-level due diligence to ensure client protection principles are respected, two of the three legs of the consumer protection stool require grant funding: regulation/supervision and building consumer awareness. Market actors need access to timely information and market research that informs them about potential market risks and which consumer segments might be particularly vulnerable. In addition, market conduct supervision that facilitates consumer protection needs investment that allows actors to test and invest in new tools that can capture consumer risks as they evolve. Therefore, traditional grant funding is needed to support responsible market development along with catalytic capital investments. 

As a complement to catalytic capital investments, our research highlights six key lessons that can help support responsible market development: 
<h3>1. Recognize market growth indicators.</h3>
This requires infrastructure investments that can contribute to responsible market development. Catalytic capital investors face four strategic decisions that will shift their role as the market develops: when to exit an investment, who would replace them, how will the investee company continue responsible behavior post-exit, and how to balance financial and social returns at the time of exit. Answers to these questions require agreement on a common set of indicators for market growth. 
<h3>2. Support initiatives that can help source market-level data.</h3>
Surveys that provide information on trends in funding and areas of concentration are crucial to support funding decisions for underserved areas. We need investments in sector-level evidence gap maps and systematic data on the volume of investments made in digital credit by funders and instruments.  
<h3>3. Design Digital Public Infrastructure (DPI) that respects users’ privacy and security.</h3>
This will have a cascading effect on newer business models because those using digital rails tend to build on existing infrastructure. Responsible market development can result from investing in the inclusive design of public infrastructure, respecting users’ privacy and security, and supporting regulations that ensure accountability. 
<h3>4. Invest in industry associations and networks to complement regulatory capacity.</h3>
Industry associations and networks can play the role of effective shadow regulators, often with the ability to monitor and identify emerging risks with market development. However, building this ecosystem requires investments beyond catalytic capital. 
<h3>5. Build regulatory/supervisory capacity.</h3>
Expanding new models requires testing tools that can detect new risks and initiatives that can bring together regulators to learn from “sister” networks in other markets. These initiatives can help augment the capabilities of market conduct supervisors but require traditional grant funding.  
<h3>6. Invest in mechanisms enabling consumer awareness.</h3>
Consumer awareness is crucial to reinforce consumer protection, but extant investment instruments may lack the incentives to support such initiatives. 

The detailed report can be accessed <a href="https://www.centerforfinancialinclusion.org/the-role-of-catalytic-capital-in-digital-markets-successes-pitfalls-and-lessons-learned">here</a>, and a discussion on the role of catalytic capital in digital credit at Financial Inclusion Week can be <a href="https://www.youtube.com/watch?v=7y8x44tLk2I&amp;list=PL30fMMRd3G_4ysbJRWLiVICDCCHEKSTMY&amp;index=5&amp;t=5s" target="_blank" rel="noopener noreferrer">accessed here.</a>

Catalytic Capital and Its Role in Digital Credit

In April 2021, a <a href="http://kenyalaw.org/kl/fileadmin/pdfdownloads/bills/2021/TheCentralBankofKenya_Amendment_Bill_2021.pdf" target="_blank" rel="noopener noreferrer">bill</a> that proposed licensing digital lenders was passed by the Kenyan parliament and is now pending approval from the national assembly. Among other things, this bill would require all digital lenders to submit product pricing to the Central Bank of Kenya for approval before launching, a move that seeks to lower predatory interest rates. Further, non-performing loans would be capped at <a href="https://www.businessdailyafrica.com/bd/economy/mobile-phone-lenders-risk-closure-in-cbk-bill-3376538" target="_blank" rel="noopener noreferrer">twice the amount of the initial loan defaulted</a>, which means lenders won’t be able to perpetually increase the amount to be paid back through late-payment fees.

Much has been <a href="https://www.bloomberg.com/news/features/2020-02-12/tech-startups-are-flooding-kenya-with-apps-offering-high-interest-loans" target="_blank" rel="noopener noreferrer">written</a> on the fintechs that have flooded the Kenyan market since 2016. FSD and CGAP published alarming <a href="https://www.cgap.org/blog/kenyas-digital-credit-revolution-five-years">evidence</a> in 2018 showing that in addition to a saturated digital lending market, an increasing number of digital borrowers in Kenya became over-indebted, which furthered them into <a href="https://www.microsave.net/2019/09/18/11310/" target="_blank" rel="noopener noreferrer">poverty traps</a>. Digital lenders such as OKash and Branch reportedly publicly shamed debtors by <a href="https://restofworld.org/2020/okash-microlending-public-shaming/" target="_blank" rel="noopener noreferrer">texting their friends, family, and colleagues</a>. Further, high-interest rates and non-transparent fees resulted in APR’s above <a href="https://qz.com/africa/1975202/kenya-prepares-to-crack-down-on-high-interest-loan-apps/" target="_blank" rel="noopener noreferrer">400 percent</a>, making it more difficult for some low-income borrowers to repay. In some instances, repayment was possible, yet it meant sacrificing other payments like food, medicine, or school fees. And finally, millions of borrowers were reported to credit bureaus for <a href="https://www.cgap.org/research/publication/consumer-protection-digital-credit" target="_blank" rel="noopener noreferrer">loans smaller than $10</a>.

During the COVID crisis, the Kenyan Central Bank issued a number of measures to ease the debt burden on borrowers, such as <a href="https://www.centralbank.go.ke/uploads/press_releases/850440997_Press%20Release%20-%20Credit%20Reference%20Bureau%20Regulations%20-%20April%202020.pdf" target="_blank" rel="noopener noreferrer">forbidding</a> unregulated mobile-based and credit-only digital lenders from reporting any late borrowers to credit bureaus. Although this helped ease debt stress on consumers during the crisis, this drove many digital lenders out of the market as levels of default skyrocketed, leaving <a href="https://www.theelephant.info/data-stories/2020/09/18/covid-19-regulatory-measures-could-widen-kenyas-financial-access-gap/" target="_blank" rel="noopener noreferrer">many Kenyan borrowers underserved</a>. The entire loan market in Kenya shrank due to COVID-19; today, these platforms lend around <a href="https://www.businessdailyafrica.com/bd/opinion-analysis/editorials/cbk-regulation-of-digital-lenders-is-long-overdue--3378386" target="_blank" rel="noopener noreferrer">2 billion shillings a month</a>, compared to 4 billion shillings in early 2020.

The proposed bill by the Central Bank of Kenya unfortunately will not address the issue of making digital credit both safe and accessible. The bill focuses on product pricing only, and it doesn’t address the underlying challenge of digital lending platforms: a weak credit assessment model. Such a model <a href="https://www.ted.com/talks/shivani_siroya_a_smart_loan_for_people_with_no_credit_history_yet?language=en" target="_blank" rel="noopener noreferrer">extracts large amounts of data from the borrower’s phone</a> and runs it through algorithms that approve or deny the loan. Many digital lenders mitigate the risk of a light-touch credit assessment with above-market APRs and hidden late payment fees, thus being able to generate profit and returns to their investors.

The primary problem is digital lenders do not measure the capacity of someone to repay, but their willingness to repay, and these are drastically different concepts. Willingness refers to the genuine disposition of a person to pay back their loan. Capacity, on the other hand, refers to the person’s ability to generate enough money in the future to pay back the loan without having to forgo essential expenses.
<blockquote class="pullquote--left">Digital lenders do not measure the capacity of someone to repay, but their willingness to repay and these are drastically different concepts.</blockquote>
For example, I might score very well on a digital risk assessment. My geo-trace shows I go to work every day, my call log shows I call my mom regularly, and my browsing history shows I do not engage in sports bets. These measurements indicate I am a responsible citizen who complies with her duties, suggesting that I have a high willingness to repay a loan. However, I might have astronomical medical expenses that the digital lender is unable to detect. Or I might be sending significant remittances to my family. Both of these relate to my repayment capacity and are measures that digital lending apps tend to ignore in favor of automated decision-making based on more readily available data.

By comparison, traditional banks run thorough credit risk assessments, sometimes so thorough that they are slow and expensive. These banks have credit committees and risk analysis departments that challenge relationship managers on the loan proposals they present. The result is that most people granted a loan have the means to pay it back. This method excludes the majority of the world’s population from the financial system, however, it also ensures that most people who are granted a consumer loan actually have the capacity to repay.

So where do we draw the line? How do we expand access to credit to low-income people and informal workers and also protect them from default? How can we measure their capacity to repay in a cheap, digital, and rapid manner? Should we prohibit alternative, digital, phone-based metrics that only assess someone’s willingness to repay?
<h2>A Possible Solution</h2>
The answer could be a measure in between. One idea is that the Central Bank of Kenya could only grant a license to digital lenders that incorporate the borrower’s capacity to repay in their credit assessment algorithms. This means, finding a way to measure, prove and integrate the person’s real income and expenses. Another option could be asking lenders to integrate proxies for repayment capacity. For example, mobile money records could be matched with the borrower's geolocation to determine where and why they are being paid and predict how stable his or her income is. Coupled with strong data protection measures, this and similar metrics could help curb the high default rate and loan-stacking among digital borrowers in Kenya without causing financial exclusion.

Further, as suggested in a <a href="https://centerforfinancialinclusion.org/making-digital-credit-truly-responsible/" target="_blank" rel="noopener noreferrer">publication produced by CFI</a>, the Central Bank of Kenya should withdraw a digital lender’s license upon surpassing a threshold percentage of non-performing loans as a share of the total loan portfolio. This would force the lenders to improve their algorithms and creatively design more capacity-measuring metrics. And finally, the CBK should explicitly require licensed digital lenders to cross-check an individual’s loan performance with each other before issuing further credit to prevent loan-stacking. Although the Digital Lenders Association of Kenya (DLAK) advocates for digital lenders to be able to receive and submit borrower information to credit bureaus, this practice has not addressed loan stacking in the past and only served to blacklist millions of borrowers for small amounts. Therefore, digital lenders should be allowed to view and report outstanding loans, yet with very limited power to blacklist a late borrower.
<blockquote class="blockquote">The CBK should explicitly require licensed digital lenders to cross-check an individual’s loan performance with each other before issuing further credit to prevent loan-stacking.</blockquote>
Kenya cannot go back to the old bank-driven model which financially excluded most of the population, yet Kenyans cannot keep paying the price for the financial experimentation of tech startups. Digital credit should be responsible, affordable, and inclusive. With this new bill, the Central Bank of Kenya is getting closer to achieving it. However, the root cause of the problem is the evaluation algorithm and the business model that stems from it. Without addressing this, little will change for Kenyan borrowers.

Digital Lending in Kenya: Willingness vs. Capacity to Repay

Digital credit has emerged as a new and profitable service offering that has great potential to increase financial inclusion. Yet, if not carefully managed, digital credit also runs the risk of excluding, over-charging, and over-extending customers.

Seven years since the first digital credit product launched, the market in Kenya has grown exponentially and hosts a diverse ecosystem with more than 50 supply-side actors. The phenomenal expansion of digital credit in Kenya serves as a test-bed for the product and offers lessons for digital credit suppliers and regulators around the world.

SPTF and the Smart Campaign commissioned MicroSave Consulting (MSC) to study the dynamics of the digital credit sector on both demand and supply sides. The output of the study was a <a href="https://content.centerforfinancialinclusion.org/making-credit-truly-responsible-webinar/">comprehensive report on the current state of digital credit in Kenya</a>. It looked at the evolving challenges in digital credit and made recommendations for a more responsible and customer-centric delivery of the product.

With participation from Smart Campaign Senior Director Alexandra Rizzi, this webinar:
<ul>
 	<li>Helps participants understand the digital credit landscape in Kenya</li>
 	<li>Assesses the progress and challenges around making digital credit responsible and inclusive</li>
 	<li>Recommends steps towards a more responsible delivery of digital credit</li>
</ul>

Making Digital Credit Truly Responsible Webinar

All is not well in the country that pioneered mobile credit. A new <a href="/making-digital-credit-truly-responsible">report on digital credit in Kenya</a> from <a href="https://www.microsave.net/">MSC</a>, commissioned by <a href="/about/what-we-do/the-smart-campaign">the Smart Campaign</a> and the <a href="https://sptf.info/">SPTF</a>, shows that with continued dramatic growth rates, the sector also experiences cripplingly high default and delinquency, enabled by poor business practices and weaknesses in both the credit reporting infrastructure and regulatory jurisdiction.

Most notably, the report reveals very high rates of delinquency and default. Among active digital loans, more than a quarter are non-performing. About 2.2 million Kenyans are said to have delinquent loans. In some cases, liberal use of refinancing and rescheduling hides this level of delinquency in lender portfolios. At the same time, the report points out that about half of these non-performing loans are for amounts less than $10. These findings are broadly consistent with results cited by CGAP in 2016, which found that 50 percent of digital borrowers in Kenya repaid their loans late, and 12 percent defaulted.
<blockquote>Despite continued growth of digital credit in Kenya, high delinquency, default and interest rates persist in the market and credit bureaus haven't yet caught up with the digital age.</blockquote>
The report also details shortcomings in credit reporting, given that many digital lenders neither consult nor report to the credit reporting bureau as fully or regularly as they should. The credit reporting bureaus were clearly set up for a pre-mobile era, which suffer from issues related to inclusion of all types of lenders, frequency of uploading data (monthly, when daily is more relevant for today’s short term loans), and ease of connection among all the players in the credit reporting ecosystem. As a result, many lenders are not consistently using credit bureaus—neither ensuring that the information is updated and correct, nor fully consulting it prior to lending.

Pricing is also an issue. The market leader, M-Shwari, which accounts for about two-thirds of all digital loans, charges an annual percentage rate (APR) of 90 percent. The low-price option provided by Kenya Commercial Bank is a fairly reasonable 44 percent APR, but the high end of the price range includes providers charging APRs well into the hundreds. Granted that these are small, short term loans where interest payments are not expected to be sustained for an entire year. Nevertheless, the promise of digital to bring down prices does is not yet in sight.

Other issues noted in the report include non-transparency regarding portfolio quality, identity theft, misuse of client data, multiple borrowing and loan bicycling by clients, and client use of loan proceeds for sports betting.

The picture that emerges suggests that the still-exploding market of very small, “nano” loans needs to be brought into more orderly operation. Consumers and providers are operating in risky ways. The current state of the market is not beneficial for either.
<blockquote>Raising the bar for blacklisting customers and public awareness about defaulting on loans are among our recommendations for improving digital credit.</blockquote>
One issue specific to this nano-loan market concerns the reporting of very small non-performing loans to credit bureaus, with negative consequences, such as curtailing of access to credit, for hundreds of thousands of borrowers. MSC, the Smart Campaign and SPTF recommend that regulations be put in place such that delinquencies and defaults among loans below some fixed amount not be reported to the credit bureau (whether US$2, $5 or $10 – the report actually recommends a cutoff of 5% of the monthly per capita GDP). It also recommends that the government launch a public awareness campaign about how credit bureaus work and the consequences of default so consumers will better understand the risks involved in borrowing.

The regulators, credit reporting agencies and lenders in Kenya are aware of these concerns and working to improve the situation. A new association of digital lenders (Digital Lenders Association of Kenya) has been formed to create consumer protection standards and the central bank is exploring ways to upgrade the credit reporting ecosystem. The Smart Campaign recommends that both lenders and regulators consider adopting the <a href="http://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles/digital-credit-standards">digital credit standards</a> and <a href="https://www.smartcampaign.org/tools-a-resources/1210-handbook-on-consumer-protection-for-financial-inclusion">model regulations</a> covering issues ranging from transparency, to the fair use of algorithms, to protection of customer data.

Kenya’s unprecedented dynamism in mobile money, digital credit and financial inclusion is envied across the world. If authorities and providers can bring the participants in these sectors into a better-functioning marketplace, Kenya will benefit greatly from the innovation the country continues to spawn.

Red Flags in Kenya’s Nano-Credit Market

Digital credit has emerged as a new and profitable service offering that has a great potential to increase financial inclusion. Yet, if it is not carefully managed, digital credit runs a great risk to exclude, over-charge, and create over-indebtedness.

During the first half of 2019, The Smart Campaign and the Social Performance Task Force (SPTF) commissioned Microsave Consulting (MSC) to study the current state of digital credit in Kenya and formulated recommendations for how to make digital credit delivery safer and more customer-centric. We propose that regulations be put in place such that delinquencies and defaults among loans below some fixed amount not be reported to the credit bureau so as not to unduly burden consumers. We also call for increased public awareness campaigns about how credit bureaus work and the consequences of default so consumers will better understand the risks involved in borrowing.

More generally, the Smart Campaign recommends that both lenders and regulators consider adopting the <a href="http://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles/digital-credit-standards">digital credit standards</a> and <a href="https://www.smartcampaign.org/tools-a-resources/1210-handbook-on-consumer-protection-for-financial-inclusion">model regulations</a> covering issues ranging from transparency, to the fair use of algorithms, to protection of customer data.

Making Digital Credit Truly Responsible

The following is part of a <a href="https://cfi-blog.org/tag/abf-blog-series/">blog series</a> spotlighting views from participants in the <a href="http://www.centerforfinancialinclusion.org/programs-a-projects/abf">Africa Board Fellowship</a> (ABF).

Two experiences with interest rate caps – in Kenya and Zambia – demonstrate the power of political forces to shape financial inclusion policies and may hold lessons for MSME lenders in other countries.

In a recent unpublished study, the <a href="https://responsiblefinancialinclusion.org/">Partnership for Responsible Financial Inclusion</a> (formerly the Microfinance CEO Working Group) examined commonalities in the origins of interest rate caps in these two countries. In both cases, signs were clear that the general public was upset about the current state of loans and interest rates. Approaching elections increased the will among political leaders to make regulatory changes that would appeal to the public.

In Zambia, a populist president, Michael Sata, was the surprise victor in 2011’s elections. In his first days in office, Sata announced his priority of cutting the cost of credit for Zambians, a move in opposition to the country’s dominant banks. His remarks sent the domestic currency into a spiral. Inflation soared, and interest rates rose. These events helped create a sense of urgency for both consumers and legislators, propelling the caps through the legislative process. In 2012, Sata led the government in successfully passing his proposed law, which capped commercial banks’ loan interest rates at 18.25 percent.

In 2013, the interest rate caps were also imposed on microfinance lending. The maximum rate was set at 42 percent for a select group of microfinance institutions and 30 percent for other non-bank financial institutions. Following Sata’s death in 2014 and the election of his replacement, the interest rate caps were removed in 2015. The government’s approach in this area now focuses on pricing transparency.

Zambia’s interest rate caps were not particularly effective. To compensate for lower interest income, the banks began to charge more fees, keeping effective prices more or less the same for consumers. The caps did not create an effective solution, and ultimately banks, microfinance institutions and regulators agreed on ending the caps. Instead, strong regulations on pricing transparency were put into law.

A similar story has been unfolding in Kenya, which introduced an interest rate cap of 4 percent above the Central Bank of Kenya Policy Rate for regulated financial institutions in September 2016. The measure was viewed as a populist move. However, in the short time since the law’s enactment, signs <a href="http://africanbusinessmagazine.com/african-banker/kenya-interest-rate-cap-coming-off/">suggest</a> it is doing more harm than good to the overall economy, including the exclusion of “higher risk” borrowers like MSMEs, decreased levels of lending, and lower profits and stock values among banks. It seems the government is now looking to remove the caps given the impacts on the economy and financial services sector.

However, there have been some positive outcomes for the Kenyan financial inclusion industry – such as more innovations, especially in digital lending, because the banks are restricted in lending, creating an opening for non-bank lenders. Some Kenyan banks have also started to buy MFIs in order to lend through them in smaller amounts. The caps have caused banks to diversify their product offerings more – to insurance and leasing.

We interviewed two alumni of the CFI’s Africa Board Fellowship (ABF) to share their experiences about the politics and practice of interest rate caps.

<img class="wp-image-25583 alignright" src="https://centerforfinancialinclusionblog.files.wordpress.com/2018/05/jacqueline_musiitwa.png" alt="" width="387" height="500" />Jacqueline Musiitwa is the Executive Director of FSD Uganda and a board member of Microcred Zimbabwe and the Central Bank of the Republic of Zambia. 

ABF: Can you share your perspective on the decision to implement, and subsequently remove, the interest rate caps in Zambia?

Jacqueline Musiitwa: "The Zambian experience seems to be similar to Kenya’s case – a populist approach with the hopes of encouraging lending to the masses. Then, quickly learning that the opposite actually happens: interest rate caps cause banks to stop lending, and the people don’t benefit. The first thing the current governor of the Central Bank did in office was reverse the caps. Increasing lending was a top priority. The Central Bank also had conversations with banks at that time about keeping interest rates low. The Central Bank learned that rate cap regulation hasn’t worked well historically, so they wanted to figure out how to work together with banks to find a solution.

Stepping back, the question is: how do banks charge interest in a way that makes sense for the population being served? Some people are unbanked for fear of charges. The Central Bank in Zambia is looking at how to get banks outside their comfort zone to serve new clients. How can they create a system of mutual trust?

Ultimately, you take a few steps forward and then a few steps back. Public trust in banks has everything to do with the safety of savings. In Zambia, the numbers were going well in terms of signing clients up at non-banking financial institutions and then in December 2016, a bank closed for three months during which time shareholders injected money into it. Clients reacted with: ‘You see, this is why we are going to put our money under the pillow’. The bank is now back but now there is still a fear of depositing in banks, so it is hard to get people to increase savings.

Regulators wrestle with how to communicate market stability when there is even just one weak link. You saw it with banks in Kenya. Dubai, Imperial, and Chase banks all went down in Kenya, and the reaction was the same. People either don’t trust banks or move to the biggest banks. Zambia is pushing through a law for a deposit protection scheme."

The full interview with Musiitwa can be read <a href="https://centerforfinancialinclusionblog.files.wordpress.com/2018/05/jacqueline_musiitwa_interview.pdf">here</a>.

<img class="alignleft wp-image-25584" src="https://centerforfinancialinclusionblog.files.wordpress.com/2018/05/ivan-mbowa.png" alt="" width="317" height="476" />ABF Alumni Ivan Mbowa, CEO of Umati Capital, offers a perspective on interest rate caps from his experience in Kenya.

ABF: Kenya’s government introduced an interest rate cap for banks, but not for non-bank financial institutions like Umati. How has Umati been affected?

Ivan Mbowa: "At Umati we’re seeing a lot more interest in our services. About half of our clients are new to formal finance. They could never get money from a bank in the first place. The other half are coming to us for additional financing, because they don’t have the collateral to get more from banks.

The funny thing is that the clients don’t always understand the nuances between a non-bank financial institution and a bank, so when they see our rates, the first impression is, ‘You guys are just flouting the law—it’s supposed to be capped.’ We have to explain that the cap doesn’t apply to Umati. A good outcome has been that there seems to be a lot more awareness and questioning from clients on, 'What is the cost of your product?'

It’s also been easier to make the argument that even if you can access bank credit, it’s good to be multibanked, so that the next time there’s a freeze or a crunch, you’re not fully exposed. Savvy clients understand that working with Umati can be a hedging mechanism."

The full interview with Mbowa can be read <a href="https://centerforfinancialinclusionblog.files.wordpress.com/2018/05/ivan_mbowa_interview.pdf">here</a>.

In one more example, the West Africa Economic and Monetary Union (WAEMU) implemented more stringent caps in 2015, reducing the cap from 27 percent to 24 percent for MFIs and from 18 percent to 15 percent for banks. In the time before the new cap was implemented, the trend in bank interest rates had been downward, as a result of competition. According to reports from ABF Fellows on the ground, the lower caps did not have a very big impact on banks, especially considering all the fees they were generating. However, caps have inhibited lending to micro and small enterprises because, for the most part, banks were already limited in their lending to this customer segment. Private investors who are interested in serving micro and small enterprises have avoided the region, given that the caps lengthen the time to break even for a fledgling greenfield financial institution. Several studies indicated that many MFIs have been unable to achieve adequate scale and efficiency in their respective business environments to be profitable and sustainable.

Given the diverse outcomes interest rate caps can have, we’d love to hear more from our readers about their experiences with interest rate caps.

Have you read?

<a href="https://cfi-blog.org/2017/02/01/are-banks-the-future-of-banking-africa-board-fellows-deliberate/">Are Banks the Future of Banking? Africa Board Fellows Deliberate</a>

<a href="https://cfi-blog.org/2017/10/20/the-board-should-not-be-the-last-to-know-why-mfis-need-independent-internal-auditors/">The Board Should Not Be the Last to Know: Why MFIs Need Independent Internal Auditors</a>

<a href="https://cfi-blog.org/2017/10/04/how-can-microfinance-institutions-in-the-middle-east-and-north-africa-manage-risk-and-meet-client-demand-governance-is-key/">How Can Microfinance Institutions in the Middle East and North Africa Manage Risk and Meet Client Demand? Governance Is Key!</a>

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The Politics (and Varied Experiences) of Interest Rate Caps

&gt; Posted by Daniel Rozas, Independent Microfinance Consultant

The following post was <a href="http://www.phnompenhpost.com/analysis-and-op-ed/interest-rate-cap-will-hurt-rural-families">originally published</a> in The Phnom Penh Post.

On March 13, the National Bank of Cambodia announced a major new policy. Starting April 1, all microfinance institutions operating in Cambodia will be required to lend at interest rates no higher than 18 percent per year. This is a deeply misguided regulation that will undo over a decade’s worth of successful financial policies.

At the dawn of this century, Cambodia’s financial sector was largely nonexistent. There were no ATMs, few bank branches, and equally few customers. In rural areas, there were no banks at all, and moneylenders held a monopoly on lending.

How times have changed!

Today’s village household has far greater control over its finances and is deeply connected to Cambodia’s growing economy. A farmer can borrow from a microfinance lender to buy seeds and fertilizer and set aside savings to help pay for his kids’ school fees. He can finance a solar panel to charge the phone that lets the family stay in touch with older children in the city, who themselves can send money home to the parents cheaply and reliably. None of this even requires the three-hour trip to town – a loan officer from a microfinance institution visits the village each week, while the village shopkeeper doubles as a microfinance agent who can send and receive payments. This picture is repeated in house after house, village after village, from the outskirts of Phnom Penh to the remotest corners of Cambodia. Today, in rural areas alone, half a million clients hold savings at microfinance institutions, and over a million borrow from them.

The new regulation puts all that under threat.

Interest rate caps are a type of price control. Like all price controls, they have a predictable effect – if something can’t be sold at a profit, it won’t be sold at all. If there’s any doubt, just take a look at the empty store shelves in Venezuela, where price controls have created a major food shortage. After all, even the most socially-oriented business has to cover its costs.

The results in Cambodia won’t be empty shelves, but it will mean fewer and more costly financial services for the very people the law is intended to help – the rural poor. To understand why, consider two loans: one for $500 and one for $5,000.

To read the rest, visit <a href="http://www.phnompenhpost.com/analysis-and-op-ed/interest-rate-cap-will-hurt-rural-families">The Phnom Penh Post</a>.

Daniel Rozas is an independent microfinance consultant based in Brussels.

Have you read?

<a href="https://cfi-blog.org/2017/02/23/new-interactive-website-exploring-the-client-protection-journey-in-cambodia-and-morocco/">New Interactive Website: Exploring the Client Protection in Cambodia and Morocco</a>

<a href="https://cfi-blog.org/2015/10/20/getting-to-scale-with-housing-finance-innovation-in-cambodia/">Getting to Scale with Housing Finance Innovation in Cambodia</a>

<a href="https://cfi-blog.org/2016/03/30/interest-rate-caps-in-nigeria-may-not-be-good-for-clients/">Interest Rate Caps in Nigeria May Not Be Good for Clients</a>

Interest Rate Cap Will Hurt Rural Families

&gt; Posted by a Nairobi-Based Consultant

Kenya and Nigeria are often heralded as two of the most dynamic economies in Africa. They could soon have something else in common: interest rate caps.

Banks in Kenya have urged President Uhuru Kenyatta to dismiss a <a href="http://www.businessdailyafrica.com/MPs-move-to-rein-in-bank-interest-rates-with-Bill/539552-3318034-item-0-102g1ui/index.html">new bill</a> which caps loan interest rates and provides for sanctions (fines and prison) directly to the CEOs of banks that fail to do so. This is not the first time such a proposal has come forward; the last one having come at a time the incumbent president was Minister for Finance. Should the President sign off on the bill it will become law, and lending rates will be capped at 400 basis points above the Central Bank discount rate which now stands at 10.5 percent.

Understandably, the prospect of such limits has caused anxiety amongst lenders. Through the Kenya Bankers Association, Kenya’s bankers immediately lodged appeals to the government arguing that capping interest rates is counterproductive and against the free market economy premises Kenya enjoys. We are yet to see how the financial markets react.

For their part, politicians are perturbed that banks have not done anything to reduce their lending rates in spite of the current low cost structures brought about by the benefits of disruption and instead have continued to reap “obscene” profits, seemingly insensitive to complaints from customers on the burden of high interest rates. The current average lending rates are about 18 percent although some borrowers pay as high as 24 percent and more for short-term as well as medium-term loans (and generally more for loans from online lenders and microfinance institutions).

Obviously, the timing is not innocent, but rather coincides with the elections coming in the next year. The President might be pressured to sign the bill to appease the lower customer segment, who are the majority voters.

One cause of public frustration over rates may stem from poor transparency, as many lenders disguise their prices to keep customers from recognizing what they are actually paying. Kenya’s consumer protections are not as well developed as they could be – as shown by Kenya’s poor scoring on this dimension in <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/global-microscope">the Global Microscope 2015</a>.

Kenya is not the only country to be actively contemplating interest rate caps. Similar proposals emerged in Nigeria a few months ago. In Nigeria the lending community strongly appealed to prevent the caps. The outcome is not yet clear. Rumors exist that the government in Nigeria has been considering reversing their proposal, but there is no formal feedback yet posted to this effect.

From the perspective of the participants in CFI’s <a href="http://www.centerforfinancialinclusion.org/programs-a-projects/abf">Africa Board Fellowship Program</a>, such as a former bank executive in Nigeria, caps are not conducive for business and indeed sometimes harm the very customers that governments are trying to protect.

Back in Kenya, we are yet to hear the clear stand of the Central Bank, and we expect that the President will not sign without listening to the Governor. On Wednesday, the Central Bank received a delegation of Kenyan banks led by the Kenya Bankers Association, <a href="http://kba.co.ke/images/stories/bankingMOU.pdf">committing</a> in a good will gesture to reduce interest rates as well as eliminate some non-interest rate charges. In response, the Central Bank <a href="https://www.centralbank.go.ke/images/docs/media/2016/PRESS_RELEASE_-_KBA_MOUfinal.pdf">stated</a>, “The CBK welcomes the move. It is a step in the right direction.”

On Friday, the Speaker of the National Assembly <a href="http://www.nation.co.ke/news/Uhuru-to-assent-or-reject-Bill-on-interest-rates-on-Monday/1056-3342706-be9ckiz/">announced</a> that the bill was being reviewed by the Attorney General and himself. It is expected that the Speaker will forward the bill to the President today. Once the President receives the bill, he has 14 days to accept or reject it.

It seems to me that we have not seen the last of interest rate caps and regulations in this industry, in Kenya and Nigeria – and indeed in Africa and elsewhere.

Have you read?

<a href="https://cfi-blog.org/2016/03/30/interest-rate-caps-in-nigeria-may-not-be-good-for-clients/">Interest Rate Caps in Nigeria May Not Be Good for Clients</a>

<a href="https://cfi-blog.org/2016/02/23/dla-piper-drafts-legal-framework-to-support-financial-inclusion/">DLA Piper Drafts Legal Framework to Support Financial Inclusion</a>

<a href="https://cfi-blog.org/2016/04/25/is-weak-governance-to-blame-for-bank-collapses-in-kenya/">Is Weak Governance to Blame for Bank Collapses in Kenya?</a>

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Kenya Considers Interest Rate Caps

&gt; Posted by Lizzy Bolze, CFI Analyst

[caption id="attachment_21293" align="aligncenter" width="490"]<img class="wp-image-21293 size-full" style="border:0 solid #000000" src="https://centerforfinancialinclusionblog.files.wordpress.com/2016/05/abf_photo_1.jpg" width="490" height="326" /> Africa Board Fellows at the HBS-Accion Program on Strategic Leadership in Inclusive Finance. Pictured left to right: Felix Achibiri, Fortis Microfinance Bank, Nigeria; Titos Macie, Socremo, Mozambique; Elijah Chol, South Sudan Microfinance Development Facility; Charles Njuguna, Faulu Microfinance Bank, Kenya[/caption]

It seems almost commonplace for financial institutions across sub-Saharan Africa to be confronted with currency devaluation, interest rate caps, political conflicts, increasing capital requirements, and disruptive technologies – not to mention the impact of wars, disease, climate change, and natural disasters. With all these complications and risks, I am left to wonder how can boards of financial institutions in Africa focus on anything other than constantly extinguishing crises?

In March, alumni of the <a href="http://www.centerforfinancialinclusion.org/programs-a-projects/abf">Africa Board Fellowship</a> (ABF) attended the <a href="http://www.centerforfinancialinclusion.org/collaborators-a-sponsors/harvard-business-school-accion">HBS-Accion Program on Strategic Leadership in Inclusive Finance</a>. During the weeklong executive education program, CFI staff had the opportunity to sit down with the four fellows pictured above to discuss some of the challenges they are facing.

A common challenge was the hardship caused by currency devaluations. MFIs often receive loans in U.S. dollars, and so as the value of local currency diminishes, squaring their balance sheets becomes increasingly tough. Elijah Chol of South Sudan reported that the Minister for Finance and Economic Planning announced a <a href="https://www.linkedin.com/pulse/how-currency-devaluation-affecting-microfinance-industry-chol-elijah">500 percent devaluation</a> of the South Sudanese Pound last December. At the South Sudan Microfinance Development Facility’s annual meeting a day later, the board was unable to take immediate action because the devaluation was so unexpected. Though prices in South Sudan’s market have since improved slightly, the impact of such extreme devaluation has posed great challenges across the microfinance sector.

Titos Macie and Socremo Bank are encountering the same problem in Mozambique. The devaluation of Mozambique’s currency happened very quickly and affected the country’s ability to pay for its imported commodities. For a country with an economy that relies on importing major commodities, the lack of money has significantly decreased the price of Mozambique’s key exports of coal, aluminum, and fish.

Recently, sub-Saharan Africa’s microfinance sector has also faced interest rate caps – most recently a proposal to install caps in Nigeria. In a <a href="https://cfi-blog.org/2016/03/30/interest-rate-caps-in-nigeria-may-not-be-good-for-clients/">CFI blog post</a> the Smart Campaign’s Nadia van de Walle notes: “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.” Felix Achibiri of Fortis Microfinance Bank in Nigeria is concerned. If the interest rate ceilings are set too low, <a href="http://www.cgap.org/blog/worrying-trend-interest-rate-caps-africa">the following challenges</a> might occur: financial service providers having difficulties recovering costs, slower growth, reduced service delivery in rural areas and other more costly markets, less transparency about the total cost of loans, and in some cases, institutions exiting the lower end market entirely.

When we met with him in March, Titos Macie mentioned how new bank capitalization requirements can abruptly arrive and require quick action. Macie had recently received word from regulators that Socremo had a very short time to comply with new bank capital requirements. His board was in the process of communicating with regulators to explain when and how they would meet this unexpected requirement.

Implementing a plan for accelerated growth is another hot topic for MFI board members in Africa. Charles Njuguna shared how his institution, Faulu Microfinance Bank in Kenya, recently implemented internal controls in preparation for an anticipated major growth period. The Africa Board Fellowship program aided his ability to support healthy growth, Njuguna remarked. His ABF program advisor facilitated an opportunity for him to visit three MFIs in Latin America and deepen his focus on customer centricity. Njuguna noted that the ABF experience spurred his institution to engage with clients by instituting more in-person meetings, a measure that has assisted him in managing sustainable growth.

If boards are to be proactive in facing moments of crisis, they need to have conversations about issues like this. When we talked with the ABF fellows, they expressed the value of the ABF program in building a network of peers to discuss the challenges and opportunities they are facing and to learn from the mistakes and successes of others.

For more on the Africa Board Fellowship program, <a href="http://www.centerforfinancialinclusion.org/programs-a-projects/abf">click here</a>.

Have you read?

<a href="https://cfi-blog.org/2014/12/19/deepening-microfinance-governance-in-africa-through-dialogue-and-exchange/">Deepening Microfinance Governance in Africa Through Dialogue and Exchange</a>

<a href="https://cfi-blog.org/2016/04/25/is-weak-governance-to-blame-for-bank-collapses-in-kenya/">Is Weak Governance to Blame for Bank Collapses in Kenya?</a>

<a href="https://cfi-blog.org/2015/07/23/lessons-learned-from-abfs-convening-of-microfinance-leaders-in-cape-town/">Lessons Learned from ABF's Convening of Microfinance Leaders in Cape Town</a>

Views from the Top: Africa Board Fellows on the Challenges of Inclusive Finance

&gt; Posted by Nadia van de Walle, Lead, Africa Partnerships and Programs, the Smart Campaign

<img class="alignright wp-image-21015" style="border:0 solid #000000" src="https://centerforfinancialinclusionblog.files.wordpress.com/2016/03/thumb_117214149e4947a6a244d87b7bbf7640.jpg" alt="" width="330" height="220" />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 <a href="http://www.cbn.gov.ng/Out/2016/FPRD/GUIDE%20TO%20CHARGES%20FOR%20BANKS.pdf">website</a> 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 <a href="http://cfi-blog.org/2016/02/23/dla-piper-drafts-legal-framework-to-support-financial-inclusion/">Model Legal Framework for Financial Consumer Protection</a>, which is based on the Campaign’s seven <a href="http://smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">client protection principles</a>. 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 <a href="http://www.slideshare.net/CGAP/2011-subsaharan-africa-regional-snapshot-12100792">twenty other countries have</a> at one point or another introduced caps, including the <a href="http://www.boz.zm/Publishing/66/66_Monetary%20Policy%20Statement%20Jul-Dec%202012.pdf">Bank of Zambia in January 2013</a> (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 <a href="http://www.cgap.org/sites/default/files/CGAP-Donor-Brief-The-Impact-of-Interest-Rate-Ceilings-on-Microfinance-May-2004.pdf">in a recent CGAP brief</a>, 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, <a href="http://www.microfinancegateway.org/sites/default/files/publication_files/sos-15-zm43-uk-nu-final.pdf">reducing their work in rural and other costly markets</a>, 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 <a href="http://www.syminvest.com/news/ecuador-interest-rate-caps-forcing-microlenders-to-increase-loan-amounts/2010/5/6/2364">Ecuador introduced caps</a> in 2007 and again in 2010, MFIs went up market in reaction. India in 2011 <a href="http://www.livemint.com/Industry/nAptDws1eOrnHgqeyMdP1H/RBI-eases-lending-norms-for-microfinance-institutions.html">enacted a margin cap</a>, 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 <a href="http://www.mftransparency.org/microfinance-pricing/Uganda/">Uganda</a> and <a href="http://www.mftransparency.org/microfinance-pricing/Ghana/">Ghana</a> and from the Smart Campaign on <a href="http://www.smartcampaign.org/tools-a-resources/1030">Uganda</a> and <a href="http://smartcampaign.org/tools-a-resources/1076">Benin</a>). 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 <a href="http://cfi-blog.org/2016/03/16/towards-authentic-transparency-a-radical-rethinking-of-disclosure-in-financial-inclusion/">transparency</a>, 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, <a href="http://r4d.dfid.gov.uk/pdf/outputs/EPS/Interest_rate_caps_and_their_impact_on_financial_inclusion.pdf">remind</a> 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 <a href="http://www.cgap.org/sites/default/files/CGAP-Donor-Brief-The-Impact-of-Interest-Rate-Ceilings-on-Microfinance-May-2004.pdf">evidence</a> 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, <a href="http://r4d.dfid.gov.uk/pdf/outputs/EPS/Interest_rate_caps_and_their_impact_on_financial_inclusion.pdf">some studies indicate</a> 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.

You can comment on Nigeria’s Guidelines on charges of financial providers, <a href="http://cbn.gov.ng/Out/2016/FPRD/GUIDE%20TO%20CHARGES%20FOR%20BANKS.pdf">here</a>.

Image credit: Accion

Have you read?

<a href="http://cfi-blog.org/2016/02/23/dla-piper-drafts-legal-framework-to-support-financial-inclusion/">DLA Piper Drafts Legal Framework to Support Financial Inclusion</a>

<a href="http://cfi-blog.org/2016/02/26/disability-inclusion-progress-in-india-ecuador-nigeria-and-elsewhere/">Disability Inclusion Progress - in India, Ecuador, Nigeria, and Elsewhere</a>

<a href="http://cfi-blog.org/2015/08/13/the-hold-up-with-mobile-money-in-nigeria/">The Hold-Up with Mobile Money in Nigeria</a>

Interest Rate Caps in Nigeria May Not Be Good for Clients

Jayshree Venkatesan

Maria Gabriela Coloma Ponce de Leon

Alexandra (Alex) Rizzi

Elisabeth Rhyne

Danielle Piskadlo

Daniel Rozas

Steve Waddell

Lizzy Bolze

Kelley Mesa

Kenya

Sub-Saharan Africa

Zambia

Cambodia

Mozambique

South Sudan

Ecuador

Uganda

Consumer Protection

Credit

Credit Provision

Default

Digital Credit

Interest Rates

Privacy

Alternative Data

Client Treatment

Financial Service Providers

Financial Technology

Fintechs

Over-indebtedness

Responsible Digital Finance

Underwriting

Customer Centricity

Delivery Channels

Digital Financial Services

Enabling Environment

Nano Loans

Policy, Regulation and Government Initiatives

Product Pricing

Transparency

Governance

Microfinance Institutions

Risk Management

Agent Banking

Data Analytics

Impact Investing

Payments

Smart Certification

Blog Post

Webinar

Report

The majority of Kenyans have mobile money accounts; their activity demonstrates digital financial services’ potential. Accion helps Kenyan innovators harness emerging technologies to create new financial services.

&gt; Posted by Elisabeth Rhyne, Managing Director, CFI

[getty src="166894400?et=sVTFj_DkTyhPkZ2Ctezezw&amp;similar=off&amp;sig=YaPangNURwTVGLyPT2Vo5ZV58BCH6GDyG1P5tFtz6lc=" width="594" height="396"]

What are the most important unanswered questions in financial inclusion?

Last week I was fortunate to participate in the small, idea-packed <a href="http://www.hbs.edu/faculty/conferences/2014-financial-inclusion/Pages/schedule.aspx" target="_blank" rel="noopener">Conference on Financial Inclusion at Harvard Business School</a>, organized by Professor Rajiv Lal. The attendees were a high-level microcosm of the financial inclusion world, a sort of mini-<a href="http://www.centerforfinancialinclusion.org/fi2020/global-forum" target="_blank" rel="noopener">Financial Inclusion 2020 Global Forum</a>. A prime purpose of the gathering was to identify a potential research agenda.

Among the ideas emerging from very rich conversations, I identified three distinct areas of research: business questions that could be addressed through HBS’s famous case method; research focused on regulation; and social science research focused on consumers. Because what one says at HBS stays at HBS, I cannot identify who offered what idea, but here is a brief summary.

An over-arching question relevant to all three of these areas was the challenge of moving customers from access to usage – i.e., creating effective on-ramps to inclusion.

1. Business Questions
<ul>
 	<li>We discussed the relative absence of banks from the financial inclusion discussion (only two mainstream banks attended) and noted that it is hard to innovate from inside an established, market-dominating player.
<ul>
 	<li>What keeps banks from offering financial inclusion products that other players do offer?</li>
 	<li>How does a large company innovate from within?</li>
</ul>
</li>
 	<li>How can the rich insights on customer needs and behavior be incorporated effectively into the business models and product offerings of financial institutions?</li>
 	<li>How can front line staff be empowered with technology to create high touch delivery models that make services more valuable to clients? (This question supports the observation one person made: seeking to increase revenue is usually a better business strategy than minimizing cost.)</li>
 	<li>What are the keys to success for building and operating a network of banking or digital financial service agents?</li>
 	<li>Cases that illustrate effective models for providing financial advice to consumers, including ways to manage conflicts of interest between providers and the advice they give.</li>
 	<li>Cases that illustrate the newly emerging SME lending innovations made possible through “big data”.</li>
 	<li>Cases that elaborate the role of alternative providers in the U.S. that serve the BoP segment.</li>
</ul>
2. Regulatory Questions
<ul>
 	<li>How can regulators best support the creation of interoperable payment systems? Considerations arise of competition policy, attracting first movers, dealing with quasi-monopoly situations, national preferences, and pricing policy.</li>
 	<li>What are effective models for public-private dialogue? The consensus was that regulators should follow the market, not lead it, but at a relatively short distance. How can they best learn what they need to know from private actors?</li>
 	<li>Creating an effective institutional architecture for consumer protection inside government.</li>
 	<li>The rapidly emerging need for consumer protection regulations for digital financial services.</li>
 	<li>As a sub-topic of the above, clarity on data rights for consumers as essential for allowing the growth of service offerings that leverage alternative data.</li>
 	<li>Case examples of applications of alternative KYC regulations – even anonymous accounts!</li>
 	<li>Alternative ways for regulators to motivate providers to protect clients, such as the use of “look back puts” that allow flexibility or self-regulatory efforts.</li>
 	<li>And finally, though I had hoped this would no longer be a burning question: what drives down microfinance interest rates, and what are the effects of interest rate ceilings?</li>
</ul>
3. For Social Scientists
<ul>
 	<li>Explore the linkages between financial inclusion and other forms of societal inclusion. One person described a "lattice of connections” that needs to be understood.</li>
 	<li>Extend the conversation about how to design products that support and build on the social relationships that predominate in the informal sector rather than supplanting them.</li>
 	<li>Apply the concept of financial health, now the subject of a national survey in the U.S. conducted by CFSI, in developing countries.</li>
 	<li>Compare the success of various strategies to help consumers make responsible financial decisions.</li>
 	<li>Understand the use of financial services through a family and lifecycle lens.</li>
</ul>
While this list as a whole is a bit daunting, taken one by one, each of these questions should attract the attention of thoughtful and rigorous analysts. They all represent core problems at the heart of the financial inclusion challenge.

Have you read?

<a href="http://cfi-blog.org/2014/08/11/lean-research-is-it-time-to-reimagine-the-study-of-financial-inclusion/" target="_blank" rel="noopener">Lean Research - Is It Time to Reimagine the Study of Financial Inclusion?</a>

<a href="http://cfi-blog.org/2013/12/19/global-forum-roundup-magazine/" target="_blank" rel="noopener">Global Forum Roundup Magazine</a>

<a href="http://cfi-blog.org/2014/10/29/the-great-competition-and-innovation-deficit/" target="_blank" rel="noopener">The Great Competition and Innovation Deficit</a>

A Financial Inclusion Research Agenda

&gt; Posted by Sergio Guzmán, Lead Specialist, The Smart Campaign, CFI

<a href="http://www.pbs.org/newshour/extra/speakout/us/july-dec12/Saloni_09-18.html"><img class="alignright wp-image-8094" style="border:0" alt="" src="http://centerforfinancialinclusionblog.files.wordpress.com/2012/10/microfinancegroup1.jpg" width="270" /></a><a href="http://www.smartcampaign.org/">The Smart Campaign</a> will soon launch its Certification Program on client protection for microfinance institutions (MFIs). In this second post in a series, Sergio Guzmán uses his experience from the field to shed light on standards that are often overlooked by MFI managers but that are a crucial part of client protection. 

When I talk with microfinance practitioners about interest rates they often say, “Clients don’t care about the interest rate; they care about the installment amount and how quickly you can disburse the loan.” Also, I’ve often heard from providers the following gem: “The most expensive loan is the one you never take out.”

In my experience, it’s absolutely true that clients are very concerned with how expensive loans are going to be relative to their monthly income, and it’s also true that when seeking a loan, clients want the money now if not sooner. But providers should not let those client traits become an excuse for non-transparency in price structure and calculations.

Let me explain:

In many countries with Annual Percentage Rate (APR) regulations , I have seen providers present clients with a monthly nominal rate. “So that clients understand better,” they say. This of course is sometimes a marketing ploy, since 3 percent a month might seem cheaper than 36 percent a year. However, if all costs have been incorporated into that 3 percent figure, it does not violate acceptable practice.

What does violate standards is when providers confuse clients about total costs by charging fees and then stating a monthly charge that omits them; that is to say, instead of the above 3 percent monthly interest rate, a provider advertises a 2.5 percent monthly rate, not mentioning additional fees (credit bureau check, insurance, disbursement fee, administrative fee, paper fee, among others) that would have to be counted in calculating a fully transparent APR. The argument that these fees are not included in the advertised interest rate because they are not strictly interest charges is a half-truth at best, and designed to obscure the facts from clients. Chuck Waterfield illustrates this superbly in his webinar: <a href="http://www.mftransparency.org/resources/understanding-the-price-curve-in-microfinance/">Understanding the Price Curve in Microfinance</a>.

The Smart Campaign standards require interest rates to be presented in a manner that avoids confusing clients about the total costs of the loan. The presentation of pricing should also include a format that would in theory allow a client to make a direct comparison to competitors. APR, when calculated to incorporate all fees effectively capture additional costs charged by providers and aggregate them to an understandable annual fee that can be compared across providers.

Providers should move away from using fees as a way to reduce the stated interest rate. Let’s say it straight: tactics like this aim to trick the client. After all, if providers try so hard to make their prices look cheaper, doesn’t that suggest  that clients ARE price sensitive and they DO care about interest rates?

Image Credit: <a href="http://www.pbs.org/newshour/extra/speakout/us/july-dec12/Saloni_09-18.html">PBS</a>

Have you read?

<a href="http://cfi-blog.org/2012/10/11/straight-talk-on-client-protection-whats-internal-audit-got-to-do-with-it/">Straight Talk on Client Protection - What's Internal Audit Got to Do with It? </a>

<a href="http://cfi-blog.org/2012/09/28/can-providers-take-more-responsibility-for-client-protection-the-smart-campaign-says-yes/">Can Providers Take More Responsibility for Client Protection? The Smart Campaign Says Yes</a>

<a href="http://cfi-blog.org/2012/09/19/new-smart-note-responding-to-complaints-at-tameer-bank-pakistan/">New Smart Note: Responding to Complaints at Tameer Bank, Pakistan</a>

Straight Talk on Client Protection – Hiding Fees When Quoting Interest Rates

&gt; Posted by Kelley Mesa
Center Director Elisabeth Rhyne's latest <a href="http://www.huffingtonpost.com/elisabeth-rhyne/why-are-microfinance-inte_b_593359.html" target="_blank">Huffington Post blog</a> delves into microfinance interest rates and what should be expected...
<blockquote>Americans often suffer sticker shock when they hear about interest rates charged in international microfinance. At annualized rates above 20 percent, most Americans start getting uncomfortable, and when they hear that in some places annual rates rise as high as 100 percent or even more, their moral outrage beepers start to malfunction. This is unfortunate, because when we are in a state of high outrage, it's hard to listen.
When asking "how much is too much?" it is important to reserve judgment long enough to examine the conditions that determine international microfinance interest rates. Here are three factors that international microfinance providers have to consider as they face the hard task of determining what constitutes responsible pricing.
<a href="http://www.huffingtonpost.com/elisabeth-rhyne/why-are-microfinance-inte_b_593359.html" target="_blank">Read the article...</a></blockquote>

Why are microfinance interest rates so high?

&gt; Posted by Elisabeth Rhyne
<img class="alignright size-full wp-image-1606" title="Elisabeth Rhyne" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2010/05/picture-1.png" alt="" width="314" height="200" /><a href="http://www.microfinanceusa2010.org/speakers/index.php#bio_id_30">Jonathan Lewis</a>, founder of <a href="http://www.mcenterprises.org/">MicroCredit Enterprises</a>, loves spirited dialogue, and that’s why as moderator of the recent Microfinance USA 2010 panel on interest rates, he went for the jugular.   He knew that the hardest – and most sensational – questions to answer are: How much is too much? and Who changes too much?  I was interviewed by a reporter recently, who kept repeating this request: Give me a number. Give me a name. We like the concreteness of the numbers and the moral satisfaction of scolding price gougers.
Of course I didn’t want to give a name or a number, though I was surprised that two panelists did come up with upper bounds for the U.S. (Paul Leonard of the <a href="http://www.responsiblelending.org/">Center for Responsible Lending</a> said 36 percent per FDIC limits, while Lynn Trojan of ACCION said that 50 percent would allow everyone to be reached sustainably).
But these questions take the dialogue in the wrong direction. They ask us to ignore the contextual factors that determine the right balance between client affordability and institutional sustainability, necessary to ensure that services remain available to all those who seek them. I am only prepared to call the price a lender charges responsible if I understand how large the loans are, what kind of cost structure the lender faces and how it uses its profits.
The best question of the day came from an audience member who asked, “Why is the price of money so emotionally charged when the price of other goods is not?” The answers to this question are very important to keep in mind as we work for consumer protection. First, loans bind people for the future. If they are not entered into carefully, they can harm clients who fall into debt traps.  People are often bad at betting on the future (as the panel on behavioral economics affirmed), and to exacerbate the situation, lenders enjoy a power imbalance over microfinance clients. Lenders must practice self-restraint, always hard, both for people and for businesses.  And the public tends to regard the costs of providing money in the form of a loans as negligible or somehow not fully legitimate.
Finally, as Paul pointed out, interest rates are not the whole story. It is important to examine the full range of terms and conditions that accompany a loan. The amount, the term, and the fit to the client’s needs and ability to repay may all matter more to the client’s well-being than the interest rate.

Hard Questions about Interest Rates