> Posted by Siddhartha Chowdri
Over the last couple of months, I’ve noticed this advertisement by the State Bank of India in several newspapers (in many cases on the front page), billboards, and other media throughout the country. Take a minute to try to figure out how much this loan costs and then continue reading. (For those outside India, 1 Lac = 100,000 rupees.)
Over the last four to five years the microfinance industry has been aggressively pushing for greater client protection standards. One place where there has been very specific and measurable improvement is in pricing transparency. This is large part due to the efforts of movements like the Smart Campaign and institutions like MFTransparency.
Although (as many people who work directly with clients know) no matter how well we as institutions disclose and explain prices in standard formats, the only thing that is of concern to the clients is how much they will have to repay on a monthly/weekly basis. Concepts of IRR, APR and time-value of money are not as much of a concern to them as how much money they are going to get and when. Regardless of whether the client is able to understand the full terms of their loan, it is extremely important that those who claim to be in the business of responsible finance stick to their guns and continue promoting full disclosure and transparency.
Although controversial for some of its other recommendations, the Malegam report on microfinance from the Reserve Bank of India has a very clear position on pricing transparency:
“To promote transparency and to make comparisons possible, the borrower must know what is the effective interest rate on the loan which s/he takes as also the other terms like repayment terms, etc. …. It is also necessary that the effective interest rate charged by the MFI is prominently displayed in its offices and in literature issued by it and on its website.”
Now please go back to the advertisement above. It seems, in India at least, that the concern for transparency on interest rates for loans does not apply to public sector banks that are catering to a middle-class, aspiring first-time car owner. Using MF Transparency’s calculator I worked backwards from the equal monthly installment of Rs. 1,725/100,000 to figure out that this loan would work out to 11.3 percent at APR assuming that the loan is for seven years and assuming the cost of capital. Let us not forget that this would likely be a fully collateralized loan and that I did not include the cost of the 15 percent of capital that the customer would have to come up with to cover the rest of the cost of the car. I for one am quite convinced that 90 percent of the people who take part in this scheme would not have any idea as to what the APR or EIR on their loan is, nor would they ever have it explained to them.
Why does the State Bank of India follow a lower standard of transparency than we are expecting from privately run microfinance institutions? Why does the Reserve Bank of India not make the same recommendations about the transparency of car loans as it does for microfinance loans? MFIs are expected to present in communication to their clients the effective interest rate, while the country’s largest bank advertises loans with a confusing claim about the size of the monthly installment.
The movement for loan pricing transparency in microfinance seems to be far ahead of what banks are being asked to do. Since I get my financing from banks and not MFIs, I hope the banks of the world will catch up with the microfinance industry and come up with a consistent way of communicating loan prices.
Have you read?
Malegam Recommendations Prompt RBI Changes, But Not as Drastic as Feared
CMEF: Could Malegam ‘Set Back the Clock’ for Microfinance in India?
Will Indian Microfinance Clients Get a Spoonful of Bitter Medicine?