Transparency in Interest Rate Pricing and Other Efforts toward

Consumer Protection

Microcredit Summit7th April 2010

Bilha Maina, Project Manager Financial Education & Consumer Protection

About FSD Kenya• Financial Sector deepening works to support the

development of inclusive financial markets in Kenya by improving competition and consumer choices

• support has been given to the Central Bank of Kenya to educate the public on the market bank charges and lending rates

• Investigated the different lending rate disclosure regimes with an aim to introduce standard measurement methods

• Consumer protection diagnostic study is underway and regular consultations with stakeholders are being undertaken

Survey on Bank Charges

Cost comparisons for current accounts

What consumers say about Bank Accounts

“The banks are doing very little to inform the public about the charges. They only talk about the advantages…Just like Bata would tell me a certain shoe is Ksh. 399, I would prefer if it was Ksh. 600 with all the charged involved in that.”

“There are times you might check your balance only to realize that they have made some deductions. When you inquire about it, they tell you to come back the following week. They might return the money and sometimes they might say they have no idea what happened to the missing money.”

“I was not told this is a flat rate I was just told you will be paying the loan at 15% interest rate. I think banks take advantage of first timers”

(Male, Older Loan, MFI & Bank, Nairobi Urban)

“I took a loan in March in one of the banks around I was surprised to find that I was taking Ksh.50000 and they deducted Ksh.10000 I asked them why they were taking this and they told me it was for insurance and what have you and they did not explain that to me in the first place. I tend to think that SACCOs do not have

any hidden charges”. (Males, Younger, Savings, MFI & SACCO, Eldoret Rural)

“Therefore, when you realize or when you have a problem that is when they show you those terms and conditions. Sometimes you do not understand as they are normally written in very small letters. And sometimes they use the banking language that jargon and sometimes you do not understand.” (Female, Older,

MFI & Banks, Nairobi Urban)

Consumers are confused..

Room for improvement

Hidden costs, unclear terminology

Cannot be compared across loans

Current

Cannot be compared across institutions

Greater transparency

Allow for informed ‘shopping around’

Ideal

Encourage competitive rates

Standard Interest Rate

Encourage honest competition

A standard interest rate measure can level the playing field through transparency, consumer awareness and honest competition within the financial industry

The case for regulation Absence of an effective and appropriate regulatory credit environment

Financial Institutions Consumer

Low consumer bargaining

power

High interest ratesHidden costs

Current Reality

Over indebtedness

Negative perceptions

“Distress”

Default

In the absence of an appropriate regulatory framework there is an increased likelihood of exploitation, especially in the case of low-income, and vulnerable consumers.

Distressed consumers & providers

“There was a person here in Nyamathi who was unable to pay for the loan so (the MFI) went to their place to get his things so they could auction them. On hearing that since the person also owed (another MFI) some money they also decided to go to the home. So both groups met and took everything.” Another...

“She was buried on Wednesday…she died saying that you should not do like me.”

The case for regulation

Effective and appropriate regulatory credit environment

Transparent process

Financial Institutions Consumer

Best case scenario

Absence of an effective and appropriate regulatory credit environment

Financial Institutions Consumer

Low consumer bargaining

power

High interest ratesHidden costs

Current Reality

Can transparency improve the perceptions of the industry and improve consumer welfare?

“Truth in lending”

APR Regulatory Framework

Legislated Disclosure

Consumer Protection

IncludeMFI/NBFIs

Ghana

Peru

South Africa

Canada

UK

European Union

USA

Malaysia

Kenya

Overview of disclosure regimes

Interest Rate MeasuresRepayment Schedule

(RS)Annual Percentage Rate

(APR)

• Simple

• Estimates monthly repayment

• International evidence suggests most preferred measure

• No indication of fees and charges

• Simple

• Estimates total cost to consumer

• International evidence suggests a consumer preference

• No indication of fees and charges

• Complex concept

• Establishes an ‘effective’ interest rate

• Most widely used measure in developed countries

• Indicates fees and included charges

Total Cost of Credit (TCC)

Annual Percentage rate

Constant ratio

Direct ratio

Actuarial method

N ratio

APR Formula

Interest methodology

Specified fees and charges

Loan term

The APR formula is a representation of these inputs and calculates an ‘effective’ interest for credit.

However, this measure is comparable only across similar sized loans and loan terms.

APR Equation and Calculation

The actuarial method is deemed the most accurate and is widely used.

The N ratio measure can be calculated easily on a calculator.

The APR calculation can be standardised and simplified, however the main challenge is for consumers to understand it and use it effectively in comparing loans across institutions.

Kenyan context: Consumer insights

Interest Rate Measure Product Take-up Disclosure & dissemination

Consumer awareness and financial needs

• TCC and RS preferred- easier to understand and already in use

• APR also felt to be useful, but complex and difficult to understand

• Credit primarily taken in emergencies

• Unbanked customers very vulnerable

• Bank procedures complicated

• Bank procedures complex and not transparent

• Greater transparency among smaller credit providers

• Consumers do not understand interest rates

• More comfortable with TCC and RS, but feel it is most useful to provide all three measures

Focus Group Insights

International research shows that consumers tend to get confused and overwhelmed and that it is important to run financial education programs and to keep the message simple.

Access to FinanceOnly 22.6% of the population(3.2 million people) are formally banked, 3.4% of the population are MFI’s clients (doubled)

38% of the population currently has, or ever had a credit product-service-facility

52% of the population has or ever had a savings product-service or facility

“The problem is most of us are very poor in maths ….they give you figures, figures, figures. I would prefer to be given the final figure for the whole year.”

“I was not told this is a flat rate I was just told you will be paying the loan at 15% interest rate. I think banks take advantage of first timers.”

“…they show you those terms and conditions……normally written in very small letters…..they use the banking language that jargon and sometimes you do not understand.”

Low-income consumers in Kenya have low levels of financial usage and are suspicious of credit providers. This can be mitigated by a transparent disclosure regime that consumers understand and have confidence in.

Source: FinAccess 2009 Source: Focus Groups 2008 & 2010

Consumer protection diagnostic

• Activities

i. Review of relevant laws and regulations, industry codes and standards

ii. Qualitative and quantitative data gathering

iii. Key stakeholders interviews• regulatory agencies, service providers, industry associations,

consumer representatives, others

Conceptual FrameworkConsumers receive quality services that are characterized by

transparency, fair treatment and effective recourse mechanism.

• Pillars

1. Regulation and supervision

2. Industry standards and codes of conduct

3. Consumer awareness

Quick Scan of CP in the sector

Bank

ing

Depo

sit M

FIs

SACC

Os(2

15)

Paym

ent

Serv

ice

Prov

ider

s

Capi

tal M

arke

t

Insu

ranc

e

Cred

it Re

porti

ngSe

mi-f

orm

al

(oth

er M

FIs

and

SACC

Os)

Info

rmal

Laws

Regulation

Supervision and enforcementIndustry Association code/standardsConsumer awareness & education

exists

proposed/in process

does not exist

Envisaged Quick Win

1. Embed CP in various sector acts2. Transparency and disclosure

– Mandatory disclosure of total cost of credit– Repayment schedule for loan customers– Plain language agreements (explained to customers)

3. Recourse Mechanism– Information of consumers on recourse channels in all

agreements & service points– Telephone, email, SMS contacts for complaints– Log of complaints, reviewed by regulator

Thank you for listening!Questions?