This presentation provides an overview of pricing in microfinance and how it is often extremely difficult to understand. It also explains why non-transparent pricing practices are prevalent in the microfinance industry and why this is an important problem. When paired with the Calculating Transparent Prices tool, this presentation provides a useful introduction to issues related to transparent pricing in the microfinance industry.

1. Promoting Transparent Pricing in the Microfinance Industry
Transparent
Pricing in
Microfinance

2. Which loan has the lowest price?
Upfront Upfront Savings Total
Option Amount Term Interest Method
Fees Savings Interest Cost
6
Option 1 $1,000 3% declining 2% 0% 0% $125
months
4
Option 2 $1,000 2% flat 2% 0% 0% $94
months
4
Option 3 $1,000 3% declining 0% 20% 5% $56
months
Option 4 All loans have the same APR.

3. Interest Rate Quiz - Answers
Upfro Saving
Poll
Amoun Intere Upfron nt s Total
Option Term Method APR Result
t st t Fees Savin Intere Cost
s
gs st
Option 6 declinin
1
$1,000
months
3%
g
2% 0% 0% $125 43% 22%
Option 4
2
$1,000
months
2% flat 2% 0% 0% $94 57% 16%
Option 4 declinin
3
$1,000
months
3%
g
0% 20% 5% $56 54% 50%
Option
4
All loans have the same APR. 12%

4. The Downward Spiral
 All MFIs have  MFI 1:
transparent prices ◦ Interest: 2.5% decl.
 MFI 2:
◦ Interest: 3.0% decl.

5. The Downward Spiral
 All MFIs have  MFI 1:
transparent prices ◦ Interest: 2.5% decl.
 Some MFIs shift to flat
interest  MFI 2:
◦ Interest: 2.0% flat

6. The Downward Spiral
 All MFIs have  MFI 1:
transparent prices ◦ Interest: 1.75% flat
 Some MFIs shift to flat
interest  MFI 2:
 All MFIs shift to non- ◦ Interest: 2.0% flat
transparent pricing

7. The Downward Spiral
 All MFIs have  MFI 1:
transparent prices ◦ Interest: 1.75% flat
 Some MFIs shift to flat
interest  MFI 2:
 All MFIs shift to non- ◦ Interest: 1.6% flat, 2%
upfront fee
transparent pricing..
And it continues

8. The Downward Spiral
 All MFIs have  MFI 1:
transparent prices ◦ Interest: 1.75% flat
 Some MFIs shift to flat
interest  MFI 2:
 All MFIs shift to non- ◦ Interest: 1.6% flat, 2%
upfront fee
transparent pricing
 Consumers struggle to
choose…. Which
would YOU choose?

9. The Downward Spiral
 All MFIs have  MFI 1:
transparent prices ◦ Interest: 1.75% flat
 Some MFIs shift to flat ◦ APR: 37%
interest
 All MFIs shift to non-  MFI 2:
transparent pricing ◦ Interest: 1.6% flat, 2%
 Consumers struggle to upfront fee
choose… Because the ◦ APR: 57%
prices are far from
clear

10. The Downward Spiral
 All MFIs have  MFI 1:
transparent prices ◦ Interest: 1.75% flat
 Some MFIs shift to flat ◦ APR: 37%
interest ◦ ROE: 10%
 All MFIs shift to non-
transparent pricing  MFI 2:
 Consumers struggle to ◦ Interest: 1.6% flat, 2%
choose upfront fee
 Profits are correlated ◦ APR: 57%
◦ ROE: 40%
to price

11. The Downward Spiral
 Prices are far from clear, and thus:
◦ Consumers over-consume
◦ Market competition is hindered
◦ Strong temptation from high profits
◦ The poor are harmed
◦ Public image is tarnished
◦ Governments urged to intervene
 Transparency, and particularly pricing transparency,
is a key element to correct this serious problem in
the microfinance industry

12. Example of Loan Pricing
 Interest rate of 3% per month
 Small closing fee of 2%
 Savings account with 15% of loan
 We pay you 5% interest on your savings
 What do you think the APR of this loan is?
 (we will calculate APR without compounding, i.e,
using the US formula, not the EU formula)

13. Declining Balance interest reflects the textbook definition of interest as a charge for the
use of money over time. APR is equivalent to declining balance interest with no fees.

14. With “Flat” interest, interest is charged on the original loan amount resulting in nearly
double the cost of declining balance interest. Why double? The area of the rectangle
under the green line is almost double the area under the red stair-step loan balance.

15. In addition, the client is often charged fees for the loan. In this example, a 2% up-front fee,
because of the short loan term, surprisingly adds 13% to the APR. A loan advertised as 36%
interest is now the equivalent of 78% APR.

16. The red area shows money
invested in business.
The blue line shows money held in savings.
Compulsory savings adds to the cost. Clients are charged interest on the original loan ($1000)
even though they never have use of that amount. In this example, the APR is now 107%.

17. Clients are paid interest, but significantly less interest on their savings than they are charged on
their loans. When earning 5% interest, the APR only drops from 107% to 105%.

18. In this example, the client pays a total cost of $131 for the $1,000 loan for 16 weeks. If she were
to renew the loan consistently for an entire year, she would pay a total of $425 for the year.

19. Average net loan balance is $360
But, the client never had a $1,000. She only received $850 because of the savings, and
then she paid back a portion each week. She paid $425 to have an average loan balance
of $360 for a year, giving an APR greater than 100%.

20. And with compulsory savings there are some months in which the client actually has more
money in savings than invested in her business, giving a negative net loan balance.

21. Why has microfinance practiced and tolerated
such universal non-transparency?
• There is no “single interest rate” for microfinance
products
• MFIs have very different products and they need
to be priced very differently
• Difficult to communicate and educate the public
about these issues
• This is the major reason for non-transparent
pricing in microfinance
23

22. Promoting Transparent Pricing
in the Microfinance Industry