Financial Literacy: How would you rate your knowledge of the financial services that you use?

What do hand-washing and financial illiteracy have in common? More than you think!

Click on this link [1] to learn the answer while listening to a recent podcast by Freakonomics radio that discusses the common reality of financial illiteracy and its contribution to economic stability.

In recent years, financial literacy has become a trend in microfinance since lender abuse and struggles of microfinance borrowers are becoming increasingly covered by the media and studied in academic research. The most common solution implemented is to attempt to increase the financial education for borrowers who are often low income and uneducated (rather than increase regulation).  

Even though microfinance has a minimal existence in the United States, the topic of financial illiteracy of Americans is receiving more attention since the events of the Great Recession.

In this Freakonomics podcast, listeners learn from researchers and policy makers about the reality of financial illiteracy among Americans, the importance of financial literacy in the United States, and the different ideas to educate and protect the American public.

If you are an American reading this blog post, how would you rate your knowledge of the financial services that you use?

---

[1] http://www.freakonomics.com/2012/01/19/what-do-hand-washing-and-financial-illiteracy-have-in-common-a-new-freakonomics-radio-podcast/

Update on the Kenyan Consumer Protection Bill 2012

Upon decision with a staff member of Consumer Information Network
(CIN), a Kenyan consumer organization, I recently learned that the
Commission for Implementation of the Constitution (CIC) made the
decision to remove the Credit Section of the current working draft of the
Consumer Protection Bill. The Credit Section contained various financial
based rights for the consumers of credit.

The reason for this decision is to put the responsibility of financial based
rights in the hands of the financial sector. The staff member of CIN
justified the decision by writing that "[t]he reason as to why we [at CIN]
agreed on this [decision] is because consumer issues are vast and diverse
and can therefore not be taken care of in a single legislation." The argument
is that the credit section was too specific for the bill.

I can understand the position of the CIC. I was not satisfied with the provisions
of the credit section of the bill; there was much need for improvement (see
my previous blog posts). This decision of the CIC would give the opportunity
for current legislation and regulations of the financial sector to be amended to
ensure financial based consumer rights.

The CIC decision is also unfortunate because the new constitution requires a
consumer protection bill, thus ensuring consumer protection will soon be a
reality for consumers. It is a shame that consumers will have to patiently
wait once again until their rights in the financial sector will be protected.

If the responsibility is now in the hands of the financial sector, when will
legislation and regulation be amended or drafted to ensure the rights of
consumers are protected? How long does the financial consumer have to
wait?

I argue that financial education, the main goal of my project, is only one
part of the equation to ensure consumer protection. Getting individuals to
change their behavior is difficult and not every consumer has the same
knowledge about the financial sector and its services.

Government also has a role in protecting the consumer. Thus, it is vital that
protection for financial consumers should be upheld through increased
transparency and regulation. The current legal framework of the financial
sector in Kenya has limited, very limited, protection for consumers.

As the CIC now puts the responsibility of financial consumer interests in
the reformation of the financial sector, I hope that the financial based
rights as represented in the Credit Section will be improved upon and
implemented sooner rather than later.

What does the repayment rate of the microfinance industry NOT measure?

During my various visits to Kenya and now as a Nairobian, I have met hundreds of Kenyan borrowers. I also had the privilege to interview over one hundred of those individuals who borrow from microfinance. To my surprise, more than the majority of my interview subjects have paid for the loan of another borrower or have known a defaulter in his or her family or community.  

This was a surprise to me because the microfinance industry claims to have a high repayment of loans. It is often estimated that 96-98% of all loans are paid in full. I never considered how the microfinance industry measures repayment. Does the industry consider who paid the loan? 

The high repayment rate reported by the microfinance industry implies that low income borrowers are able to invest their loan in their business that helps it to grow and generate a profit that allows them to pay back their loan. 

From the individuals whom I have met and interviewed, I have learned that borrowers often use funds from sources other than the profit earned from their business(es) to pay back their loan(s). These other sources include borrowing from more than one lender, family members, individuals in their communities or self-help groups. Most of the Kenyan women whom I meet throughout Nairobi and the Rift Valley participate in at least one self-help group, specifically Chamas that is an informal savings group in which each member contributes a predetermined amount of money to the group at each meeting and one member is chosen to keep the contributions. Despite the proliferation of opportunities from financial institutions and banks, these sources of informal finance in Kenya are still common to help individuals cope with daily life, including the requirements of microfinance. 

As explained, loans are often paid with the help of others. Loan repayment is not the sole responsibility of borrowers. Most often, this responsibility is passed to the guarantors of borrowers who are in the same lending group. If a borrower defaults, his or her guarantors are legally responsible for paying the loan, including penalties. In fact, the microfinance lender will freeze all future loans of the group and even take the savings of the guarantors until the loan balance of the defaulter is paid in full. This puts financial and social pressure on borrowers and their guarantors who have their own loans to repay. Does such a situation contribute to the over indebtedness of microfinance borrowers and increase the cases of default in the microfinance industry?

High repayment rate is a matrix used to ensure successful lending practices of financial institutions, but does it guarantee a happy ending for borrowers? The repayment rate of the microfinance industry should account for who pays a loan. After all, the purpose behind the creation of microfinance was poverty alleviation rather than the current weakening of the community relations, financial stability and social capital of borrowers that I witnessed in Kenya.

I argue that when a loan is paid in full, the lender always benefit, but borrowers do not.

A Microfinance Story for those Questioning the NEW Kenyan Consumer Protection Bill

The new Kenyan constitution requires the government to adopt a consumer protection bill into law. At the moment, the draft of the bill is currently under the review of the Commission for the Implementation of the Constitution (CIC). This is exciting news as the consumer protection bill in 2007 failed to be passed by parliament. With the new interest and demand for the bill, here is a story to motivate the Kenyan government to take to heart the millions of consumers in Kenya that are in need of protection through this new bill.
 

Agatha is one of many borrowers discouraged by the practices of microfinance because of the lack of protection for consumers such as herself. Several years ago as a mother of three, Agatha wanted to help support her family by opening a clothing shop as her own business, the dream of many Kenyan women. She explained to me that she finally became a member of a microfinance institution after a referral from a friend in order to gain capital and knowledge to grow her dream. 

After borrowing her second loan, the practices of her microfinance program began to change dramatically starting with 3% increases in interest for each new loan. Her payments on existing loans also began changing as well without any prior explanation or notice from the loan officer she trusted and called teacher.  She began to question if such changes were permitted, but the microfinance institution did not give her a copy of her loan agreement before or after signing it.

With such changes, many of the borrowers in her self-help group began missing loan payments for which the other members became partly responsible for paying, including the accumulating penalty fees charged after a missed loan payment. Agatha herself was barely able to pay her third loan, but only through the help of family and friends.  It was then that she decided to leave the world of microfinance for good. These experiences continue to deter her from borrowing to this day because of the lack of protection of borrowers such as herself and her friends in the self-help group.  

How many more borrowers share Agatha’s experiences? If the Consumer Protection Bill is passed, Agatha’s story, and the story of countless others like her, can be a consumer problem of the past due to several key protections in the new bill. 

First, the Consumer Protection Bill requires lenders to deliver a disclosure statement to every borrower summarizing their credit agreement. (An improvement to the bill: all statements should be offered to clients in any of the official languages of Kenya, not just English.)

Second, within thirty days of increasing the annual interest rate of a loan by 1% or more that results in the increase of a borrower’s loan payment amounts, the lender must submit a new disclosure statement to the borrower stating the changes. 

Third, fees that result from the default of a borrower are limited to responsible charges incurred by the lender in collecting payments and repossessing or protecting the security pledged by the defaulter. 

Fourth, a borrower can pay the full balance of his or her loan at any time without penalty. 

Fifth, lenders can not release or make representations of any credit agreement in any form unless complying with the prescribed requirements set by the bill. Thus, the bill will provide privacy of information for borrowers. 

Although the Consumer Protection Bill should include many more consumer rights, if it is passed, Agatha and other microfinance clients will have something to celebrate during the New Year. Agatha's story shows the potential impact that the bill could make in the lives of microfinance clients. With the expansion of financial based consumer rights in the bill, microfinance clients will be able to access improved financial services that will enhance a long and healthy financial future for all Kenyans.