Strategic Benefits of Adopting Client Protection Principles in Microfinance

By Fehmeen Ahmed Khan and Saman Nizami,

Microfinance Focus, Oct 8, 2010: Consumer protection is the latest catchword in microfinance owing to its strong association with the concept of responsible finance, however, the idea has received less support from microfinance institutions (MFIs) than what it deserves.  Although a significant number of stakeholders in the microfinance sector have adopted these principles voluntarily, convincing new MFIs is a challenging task because firms may feel it is tantamount to trading immediate and material benefits for distant, uncertain and intangible gains.

In reality, because consumer protection guidelines help MFIs strengthen their social performance, they actually gain a few strategic advantages, as explained below.

Access to the Best Human Resources through corporate culture

As in other industries, human capital is a valuable asset in microfinance as well. A thorough adoption of client protection frameworks can penetrate an MFI’s organizational culture, and vice versa. Once the corporate code of ethics (also part of corporate governance frameworks) reflects the importance of open communication, honesty, transparency, and positive competition, etc., employees will begin to reflect these values in their daily behaviour.

Resultantly, over a period of time the MFI will gain recognition in the job market for its compelling culture and attract the best possible talent on acceptable terms & conditions.

Protect Portfolio Quality through responsible pricing and risk measurement

Over-indebtedness of microfinance clients is often caused by incomplete/poor assessment of client risk appetite, and this problem is fed by deceptive marketing of interest rates which lead borrowers to believe the rates are attractively low. MFIs may be tempted to follow these practices to widen their client base and portfolio size in the short run, not realizing it will deteriorate their portfolio quality and result in other undesirable consequences.

The solution is to refuse the loan request if there is a high risk of client over-indebtedness, and to emphasize transparent pricing by publishing the effective annual interest rates and all associated charges upfront.

Using Client Goodwill for Marketing Purposes

Another strategic advantage pertains to customer loyalty, which is based on trust gained over time through various means, such as efficient client redress mechanisms, data privacy, non-aggressive and forewarned collection credit practices, transparent pricing, to name a few. Strong client relationships can not only withstand competition but also give MFIs access to valuable feedback that can help managerial processes become more efficient and lead to improvements in product features or the introduction of new products that consistently serve unique and varying client needs.

Lastly, the customer-protection philosophy presents itself as a market positioning attribute and when all these benefits are combined and presented to the customer, the MFI will eventually become a part of their clients’ evoked set because customers will feel safe & comfortable while dealing with the organization.

Access to Funds

MFIs may avoid full disclosure fearing negative publicity and loss of competitive power, however, now that the microfinance sector has branched out to include for-profit missions, investment funds are more interested in MFIs that perform well on both financial and social audits.

This may be a proactive measure (to align profit-motivation to the original mission of high-impact social performance) or a reactive measure (to ward off criticism from anti-commercialization skeptics), but in either case, MFIs need to prove that client-welfare is top priority, by emulating principles such as transparent pricing, avoidance of over-indebtedness, data privacy, etc. Broadly speaking, microfinance providers can leverage their social performance to gain recognition and access to low-cost funds.

Better choices of consumers will help marketplace prosper

Another bi-product of client protection principles is the ability of consumers to make informed, and hence, better decisions (refer to the principle titled, transparent and responsible pricing) which is one of the factors leading to greater market competition. In the long run, the microfinance sector will prosper as entry barriers diminish, product variety increases and prices (interest rates, compulsory savings, and additional fees) become more competitive.

Granted, it is the moral responsibility of MFIs to protect their clients, who are generally poor and vulnerable, and to desist from exploiting their lack of financial literacy. However, there are plenty of other reasons that call for the same behaviour. Instead of relying on MFIs to voluntarily adopt client protection principles, social investors, donors, policy makers and other members of the microfinance sector, can proactively reach out to MFIs and educate them about the tangible benefits of this move.

Authors:  

Fehmeen Ahmed Khan is the Founder of Microfinance Hub Blog and also appears as a guest blogger at the Red Cloud Blog.

Saman Nizami is a finance professional who works in an individual capacity.

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