Wednesday, 2 February 2011

Hidden charges, financial literacy, quasi-monopoly market demand more regulations in microfinance

Main issues requiring government regulations in the microcredit sector:

1 - Quasi monopolistic market: microcredit organizations do not operate in free and competitive markets but operate business in often quasi-monopolies. Furthermore, according to specialists: competition is only on non-price terms (Nimal Fernando, Asian Bank for Development).

2 - Low Financial Literacy: Wrong assumption that microcredit clients are rational economic actors. On the contrary, as demonstrated by the recent global financial crisis, also developed countries need to increase consumer protection legislation. In the United States, for instance, the Obama administration, enforced The Credit Card Accountability Responsability and Disclosure Act of 2009 and in 2010 established the Consumer Financial Protection Bureau to protect consumers of financial services from abusive, deceptive and unfair practices.

3 - Lack of Transparency: Transparency is another key point. Consumers should be put in the conditions to choose the right product after comparing effective interest rates and loan terms. Malpractices such the ones below transform loans from opportunities  to obligations:
up-front fees, compulsory savings, insurance premium subscription; distorted calculation of  the interest rates (usually based on the original loan and not on the residual amount of debt). Professor Subrata Mitra from the Indian Institute of Management in Calcutta, describes in his article Exploitative Microfinance Interest Rates how these tricks litteraly blow up the effective rates.

for more information on these issues you can read the article by Prof. Aneel Karnani published on the Stanford Social Innovation Review entitled Microfinance needs regulation

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