Microfinance – Why transparency is not enough and what to do about it

Microfinance – Why transparency is not enough and what to do about it 
By Cristian Jurma, General Manager, Vitas Romania

The topic of transparency is front and center in development today, and nowhere has that caused more soul-searching than the microfinance industry. Fallout from the global financial meltdown brought waves of over-indebtedness to many saturated microfinance markets, and several years later that crisis boiled over into tragedy when aggressive loan collection tactics led to a rash of client suicides in India. The result was a massive public backlash against microfinance institutions that left the industry scrambling to respond.
This call to action resulted in a broad-reaching, coordinated effort among industry leaders to create formal standards for client protection. Five years into the industry’s efforts to make transparency mainstream, it is my view that inherent tensions between transparency and competitiveness mean that self-regulation alone will not achieve effective transparency. Our clients will only truly benefit from transparency if there is a broader cultural shift toward client education.
Currently, there are three core bodies that have set standards around transparency: the Smart Campaign, the Social Performance Task Force, and the European Code of Conduct. Based on these, a number of certifications and ratings have been developed, some of which are assessed externally, such as Moody’s SPA, Microfinanza ratings or the Microfinance transparency “Seal of Approval;” and some of which can be done through self-assessment, using tools from the Smart Campaign, EU Code of Conduct, or the MIXmarket. All of these, so far, are voluntary.
The European Union provides a good example of how these ratings work: microfinance regulations vary greatly across member states, so the European Code of Conduct provides a set of standards around, for example, management, governance, and investor relations, to signal to customers, investors and regulators the quality of a microfinance institution. Following a recent pilot with several institutions, the European Commission is planning to make compliance with the Code mandatory for any funding or technical assistance from European sources.
The spirit of the EU Code, like other transparency initiatives, is to ensure that microfinance continues to be a tool for poverty alleviation – the importance of which no microfinance provider disputes. However, when it comes to implementation, many microfinance leaders are hesitant to move forward.
First and foremost, all of the current transparency initiatives require heavy upfront investments: the costs of assessments, ratings, and the operational changes required to comply add up quickly. Furthermore, to comply with price transparency requirements can mean losing out to competition. Unless all institutions agree to simultaneously publicize their pricing in the same manner, clients with low financial literacy will view a more transparent organization as more expensive, because they see the full cost of the loan. This means that well-intending institutions, especially first movers, can find themselves at a competitive disadvantage.
My organization, Vitas Romania, in partnership with the Microfinance Centre, has been involved with promoting the EU’s goals for a more responsible financial environment in Eastern Europe. In 2014, we organized a workshop with nine of the most important MFIs and credit unions in Romania, to discuss the importance of self-regulation in microfinance, compare current standards, and clarify questions on the EU Code of Conduct with a representative from the European Commission. An informal aim of the gathering was to get a commitment of the participants to full pricing transparency, which should be formalized in the coming period. However, it became clear from these meetings that whatever the strengths of the EU Code, there are still limitations.
For our clients to truly benefit from transparency, MFIs need to change their culture. Transparency means nothing if clients lack the financial literacy to read a loan contract and understand its implications. The single biggest impact would come if we invest in educating our clients and our staff, especially those who are on the frontlines of interacting with clients and therefore promoting transparency and understanding. Since 2011, Vitas and MFC have partnered to develop a Financial Education project, educating staff from five MFIs to provide counseling in debt management to about 260 clients. I believe that this kind of education needs to be scaled up across our industry, and should become a second pillar of the transparency movement.
Adherence to standards, policies and procedures is vital, but for microfinance to maintain its founding mission, it must go hand in hand with financial education for clients and a shift in institutional culture that ensures that staff put clients ahead of profits. That will be true financial inclusion.
Cristian Jurma is General Manager of Vitas Romania, a subsidiary of Vitas Group. Vitas is a commercial holding company created by Global Communities as a long-term vehicle for fulfilling Global Communities’ mission in microfinance and small- and medium-enterprise finance. Follow him at @vitasgroup