UNITED NATIONS CAPITAL DEVELOPMENT FUND    Microfinance

Issue 12 / May 2005

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Update

on the International Year of Microcredit 2005

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Past Issues

1. Why is consumer protection important to microfinance?

I believe that there are principled reasons and pragmatic reasons. Modern microfinance has been built on the foundation of serving the needs of poorer clients. Protecting, not exploiting, these clients has been an important part. In this sense, microfinance has always been 'pro-consumer', as Beth Rhyne, Senior Vice President of Accion, and others have said. However, as microfinance becomes more commercial and competitive in many countries, even those who do not subscribe to all of the original principles should see pragmatic reasons for ensuring that consumers are not exploited: for one thing, the effects of a political or popular backlash against 'exploitative lenders', which has been seen in various countries to date such as Bolivia and South Africa, can be devastating, even to the good practitioners.

2. How can customers be protected? What are the main approaches (implemented in developed countries) microfinance may look into?

A bedrock principle of consumer protection is transparency: that the terms and conditions of a contract should be clear and understood by consumers upfront. In some places, a standard basic credit contract must be used; in others, a standardized way of quoting the effective interest rate. Of course, to give effect to this, consumers need to understand what they are getting into-hence consumer financial education is an aspect of consumer protection which is gaining increasing attention. On this foundation, in developed countries, consumer credit-related laws go further to prohibit certain types of behavior by lenders and require that safeguards be built into contracts. In addition, consumer protection regimes define ways in which consumer complaints and grievances against suppliers can be addressed effectively. This is because the conventional court system is usually not effective to handle relatively small consumer credit related issues.

3. What has been done to date in the microfinance sector to safe guard customers?

This varies enormously by country, and reflects in part the approach to regulation in each country. South Africa is an example of a developing country which has perhaps gone furthest to date, first by setting up a microcredit regulator in 1999 which focused on consumer protection; and now with a new National Credit Bill, due to be passed this year, which would mainstream microcredit regulation and subject all forms of consumer credit to the same protection framework. At the same time, international networks like Accion and the MicroFinance Network have recently drafted and adopted Pro-consumer pledges as a form of self-regulation by their members and affiliates in the countries in which they operate.

4. What are the pros and cons of state regulation versus self-regulation?

Self regulation is likely to be much more responsive to the requirements of an evolving industry; but it is often regarded as toothless-once a member is expelled from a self-regulating association, that member can often continue its bad practices with impunity. State regulation tends to be the flipside: much less flexible, but with the enforcement power of the state over all defined transactions or entities (although the enforcement power may be limited in fact to the capacity of the regulator, since other state agencies such as the police may be stretched implementing other priorities). Then there are hybrids in between, such as South Africa's MicroFinance Regulatory Council. Much depends on the stage of development of the sector and the extent, perceived or actual, of abuse as to which enforcement regime is appropriate.

5. What should policy makers and MFIs know before embarking on consumer protection measures?

In many ways, this is a new issue in microfinance, although it is rapidly growing in importance. A big trap to avoid is rushing to regulate in this area of conduct regulation, just as in an earlier era of microfinance, CGAP Senior Advisor Rich Rosenberg and others counseled that there should be no rush to regulate MFIs prudentially. Another is avoiding importing inappropriate legislative models from other countries. There are few developing countries today with a well developed consumer protection framework, at least in microfinance. To consider only the well known developed country consumer credit codes such as in Australia, the UK or the US, without carefully assessing local circumstances could lead to outcomes which are perverse-for MFIs and their clients.

* David Porteous is a consultant in inclusive financial sectors to a range of clients, and the author of the new CGAP Focus Note No.27, "Protecting Microfinance Borrowers," May 2005:

http://www.cgap.org/publications/focus_notes.html