Making Disclosure Work for Low-Income Financial Consumers

A micro-borrower in the Philippines struggles to figure out which one of several loans is the least expensive—one comes with a flat charge, another a weekly interest rate, and still another a monthly rate with an upfront deduction. In Senegal, a recent survey of low-income consumers revealed that more than 99% of respondents were unaware of their right to standardized price information on the loan and deposit services they used. In Mexico, poorer consumers looking for a cheaper way to save, reported to CGAP losing 25%, 50%, or even their whole savings due to hidden fees on “low-balance” accounts they were not aware of until it was too late.

Consumer research supported by CGAP and others around the world is painting a similar picture – customers face many challenges in understanding the prices, terms and conditions of the financial services they use, and this lack of understanding carries very real economic consequences. Even if consumers are fortunate enough to have multiple options for loans, savings or payments services, many find it very difficult to “shop around” and identify the option that offers the best value-for-money. Sometimes the problem is the opposite, when excessive fine print floods consumers with too much information and distracts them from the factors that are most important for their decisions—factors such as total finance charges.

Situations such as these are quite common for poorer customers in base-of-pyramid (BOP) financial markets. Fortunately, policy makers in each of the countries mentioned above are taking steps to improve the situation and make financial services more transparent.

Latest research shows that, disclosure is the top focus of financial consumer protection in developing countries, and a new CGAP Focus Note provides practical tips for regulators seeking to improve disclosure rules. It describes the pros and cons of approaches that different countries are taking to ensure that consumers get information from their provider that helps them actually understand what they’re getting and choose appropriate products. The research draws on initial insights from consumer testing and regulatory experiences from the following countries/regions: Armenia, Bosnia–Herzegovina, Cambodia, Ghana, Pakistan, the Philippines, Peru, and the West African Economic and Monetary Union (WAEMU).

One obvious issue explored in the Focus Note is what information should be disclosed. Everyone would agree that consumers need to understand the price of the service they are receiving. For a loan, for example, this helps the borrower assess the affordability and the risks that come with borrowing. But achieving this standard is actually quite challenging. Usually the interest rate is only part of the story.Fees, commissions, and credit life insurance premiums all add to the actual cost. And rarely do providers define and calculate each of these price elements in exactly the same way.

The Focus Note helps policy makers navigate the realities on the ground. For example, most people – lower-income or not – are confused by percentages. This shows that it is important to develop alternatives or complementary measures to the Annualized Percentage Rate (APR) requirements . The Focus Note points out that some countries may start by mandating that lenders present consumers with the “total cost of credit” measure, which is more intuitive for consumers to understand and for providers to comply with. Since most borrowers also focus a lot of attention on the periodic payment amount or installment, a standardized repayment schedule is also emerging as part of the essential disclosure package for loan prices.

But consumers need more than just the price if they are to make good choices. Another area requiring attention is disclosure of other key terms and conditions that may pose future costs or risks. For example, what happens if I miss a loan payment? What are the terms of my mandatory savings requirements? How do I make a complaint?

Perhaps equally important to the “what” is the “how” of disclosure. How can the format of disclosure actually affect the decisions and behavior of lower-income consumers? Here the Focus Note looks at options for making sure that information is accessible, as “plain language” as possible, and coming at the right time. For example, if prospective borrowers get a “Key Facts” sheet on the loan terms in a format that they can take home and consider, they are perhaps more likely to weigh carefully the overall price and key terms and risks of a loan than if they get the same information in a complex contract at the loan closing. One very practical recommendation is that regulators test proposed disclosure formats with consumers beforehand, to see if the client segments they have in mind actually comprehend the information.

Some disclosure regimes are still more ambitious, going beyond improving the “what” and “how” of information received by individual consumers to rules that may make markets more competitive, bring down prices, and improve service quality. If regulators require providers to publish standardized price information, competitors can benchmark themselves against one another. At the same time, financial authorities and others such as the media or microfinance investors will have what they need to create pressure for service enhancements.

At a minimum, providers of financial services to consumers with lower levels of income and education must meet the test of transparency. The microfinance sector has been quick to criticize when politicians and journalists push for measures such as interest rate caps to protect these consumers. Yet we must have a credible alternative to propose. Well-formulated and implemented disclosure rules are the foundation for more informed consumers, better financial decision-making, and more competitive markets. They are a cornerstone of responsible finance.

When you look to the future of financial inclusion in the markets you know best, what role do you see disclosure rules playing in helping build trust and ensure transparency? And do you think it’s realistic to expect that consumers with lower levels of income and education can be the drivers of making markets more competitive, by proactively comparing their options and rewarding the better providers and products with their business? Or does it seem more realistic that pressure from regulators, journalists and others such as microfinance investors is likely to be needed to encourage transparency and value-for-money in BOP markets?