Part 4: What is the industry doing to protect borrowers?

February 15, 2011

By: tinkgunn

In the past few months, the Indian microfinance industry has been in the spotlight. A few Kiva Fellows wanted to learn what the issues there are, and what can be done to prevent them in the future. We have presented our findings in a series of blog posts over the past few days. Given the inherent complexities, the multiple viewpoints and an ever changing political and legal landscape, our work is only intended to provide a top-level summary of the situation as it stands now. If you are interested in learning more about microfinance in India, we encourage you to explore these issues beyond what is presented, and to draw your own conclusion.

This is the fourth in a series of posts:

What is the industry doing to protect borrowers?

In part three of this series, Bridget outlined a number of steps that microfinance partners take on a micro level to prevent over indebtedness of clients.

One of the biggest challenges in the industry is oversight and regulation on a macro scale. Whilst in countries like the US there are regulations to protect borrowers, this is often not the case in many of the countries where Kiva has field partners. Kiva can’t choose not to work in countries without credit agency regulations as these are often the places where the need for enabling access to credit for the poor is greatest.

So what can be done?

As the microfinance industry matures, a number of bodies have grown to try and tackle the issue of client protection. The Consultative Group to Assist the Poor (CGAP), has outlined a number of key principles which should be taken into account by any body acting in the sector. These “Client Protection Principles” form a baseline from which each MFI should act with regards to Client Protection. CGAP provides a due diligence questionnaire for investors to use in evaluating new partners in terms of client protection.

Alongside this, the SMART campaign encourages MFIs, funders and individuals involved in microfinance to sign up to advocate the six key Client Protection Principles- uniting them in the common goal of keeping clients as the driving force of the microfinance industry.

SMART says: “Protecting clients is not only the right thing to do, it’s the smart thing to do.”

One of the tools which Kiva uses to assess its partners on client protection is the CERISE Social Performance Indicator Tool (SPI). Kiva uses this to ensure that their partners aren’t doing what some of the poorly run organizations in India have been doing. The tool uses the key principles as outlined in the SMART campaign.

How can social performance be assessed?

The SPI Tool aims to provide an audit of the current state of a variety of practices at the MFI. These include how the MFI targets clients, how poverty levels are measured and what collateral (if any) the MFI asks for, for example. The tool also assesses the products delivered by the MFI, what additional benefits or wrap-around services are offered to the clients by the MFI (eg business training, emergency funds) and how staff are incentivised.

As part of the process, the MFI is presented with a number of questions relating to the Client Protection Principles (CPP) outlined by the Smart Campaign and CGAP.

Some of the areas covered are:-

Finding out if the management regularly monitors levels of borrower over-indebtedness and uses that information to improve products, policies and procedures.
Whether the MFI offers multiple loan products or flexible ones that address different business and family needs.
Whether the MFI checks a Credit Registry or Credit Bureau for borrower debt levels and repayment history where available. When not available, the MFI should check internal records and consult with competitors for the information on clients.

Transparency is a key issue here too- the SPI assesses whether prices and terms of products are fully disclosed to the client prior to sale, including interest charges, penalties etc, and whether those can change over time.

Other issues taken into account include:-

Responsible pricing, reasonable rates of return (that benefit the client as well as the MFI)
Client understanding and consent; a clear loan contract should be in place which shows an amortization schedule with principal, interest and fees listed as well as the number and due dates of installment. Debt collection practices should also be made clear.
Staff training and communication with clients is also assessed in the SPI audit- this involves ensuring that they understand the product, the terms of the contract and their rights and obligations. This must take into account literacy limitations such as using local languages and reading the contracts out loud to the illiterate.

This tool is used across the microfinance industry and as of last year, Kiva is carrying out a Social Perfomance Audit for every single active partner (carried out by Fellows in the field).

How much responsibility is taken on a country level?

As I mentioned earlier, credit regulation varies hugely depending on the location of the MFI. For example, within the US one of the pieces of regulation that borrowers are protected by is the Fair Debt Collection Practices Act, enforced by the Federal Trade Commission. This act “requires that debt collectors treat you fairly and prohibits certain methods of debt collection.” There is also bankruptcy law. Bridget, KF13 at ACCION Texas-Louisiana notes “I’m told that if a borrower files for bankruptcy, then ACCION can’t even talk to them or they’re in violation.”

There are also laws such as the one in Texas which makes it illegal to collect someone’s homestead from them. ACCION doesn’t accept people’s homes as collateral in Louisiana either, even though they legally could. They’ve chosen not to risk putting someone out on the street.

Working within countries that do have regulated credit management certainly makes client protection easier, but a large proportion of MFI’s are acting within unregulated areas.

Within Ghana, where I have been living and working for the past three months, whilst the Bank of Ghana acts as a regulatory body for the formal banks, there is no universal regulatory body for credit management within microfinance. It is an ongoing issue for the MFIs in Ghana- when I asked a loan officer at Christian Rural Aid Network how he finds out if a client has taken a loan with a rival MFI, he simply told me “If the loan officer from Sinapi Aba (another Ghanaian MFI) is visiting the client too, we know that the client has been taking loans from both of us”. It is quite frightening to think that credit regulation is down to pure chance.

It is not all bad news, however. Networking bodies like GHAMFIN and the Ghana Cooperative Susu Collectors Association exist to educate and promote communication between MFIs, and as we speak CRAN and a few other MFIs are in discussions to set up their own private credit checking process between their clients.

It is the responsibility of each MFI in Ghana to write their own protection and debt collection principles. George Tokpo, Microfinance Director at CRAN told me “Being clear about client protection is key to everything we do. Our core value says “Paramount are the people we serve” and we need to live by this value every day. It is a matter of integrity for CRAN, and it also gives us a competitive advantage when we are clear with clients.”

I hope that you have found this series on the current issues the industry faces an interesting introduction. As Tran noted in post number one, we urge you to continue your own research further via the links provided throughout if you would like to learn more.

By Jacqueline Gunn, KF13 Christian Rural Aid Network, Ghana and currently in transit (and a 45 degrees celcius heat drop) to KF14, HOPE Ukraine