Pricing transparency and performance in the microfinance industry: Truth-in-lending, profitability, scale, and funding

Abstract

Microfinance consumer protection is identified as essential to the development of inclusive financial systems. Beyond protecting existing consumers, truth-in-lending practices enhance the credibility of Microfinance institutions in providing responsible financial services to un-banked populations. This research explores the value of pricing transparency i.e. the alignment of what a microfinance institution (MFI) communicates as its interest rate to the borrower as compared to its actual interest rate to gauge the robustness of consumer protection relative to the MFI’s financial performance. The research applies a focus around the main concerns a manager of an MFI faces when deciding whether to implement transparent loan pricing – namely, that it will not diminish the MFI’s performance in terms of profitability, scale or funding. There is compelling evidence that transparency and profitability are not necessarily mutually exclusive. Transparency better serves customers, which leads to an expanded client base with lower default rates and a better reputation for the MFI. It helps attract and retain donors and investors who are increasingly responsive to social performance metrics. Finally, transparent practices form the basis for enhanced accountability, which is fundamental to establishing the credibility of the MFIs in providing financial access to the poor and contributing to the industry’s long-term viability.JEL Codes: G21, D82, L25, G23, E43, G28, D18,