Setting Standards for Microfinance

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"A plea for lower interest rates is in fact a plea to increase the size of our loans significantly. Doing that can only have two outcomes: the overindebtedness in our clients or moving to a different segment of the market, which amounts to mission drift," the letter says. The bank argues that it's better for poor people to have access to credit than not—even if the interest rates are high.

How It'll Work

MicroFinance Transparency will collect information from all microcredit lenders and store it in a database on its Web site, mftransparency.org, that's searchable via the Web by anybody who is interested. (The group hasn't said when that information will be posted on its site.) All of the loans will be converted into annual percentage rates based on the true cost of the loans. In addition, all of the costs associated with the loan, including any additional fees charged by the lenders, will be rolled into the total. Waterfield says most microcredit organizations will submit their data, and, for those that don't, the information will be collected by gathering contracts from their borrowers and crunching the numbers.

These days, most microcredit organizations market their loans using a monthly interest rate, say 2% to 4%. That may sound reasonable to people used to paying even higher rates to village loan sharks, but the lenders don't spell out to borrowers that these are flat rates—meaning they're paid on the total loan amount, even as the borrower pays down the principal during the year. Yunus' Grameen Bank operates differently. It charges a 20% annual rate on a declining basis. Each week, when Grameen borrowers make their payments, the principal of their loan and the basis of future interest payments gradually declines. The APR of a Grameen loan is actually about 10% per year.

One of the dangers to the microcredit industry is that countries may put limits on the amount of interest the organizations can charge borrowers. Already, Nicaragua, Ecuador, and South Africa have set ceilings. While that may sound like a reasonable move, if rates are set at unsustainable levels it could smother some legitimate microlending activity. There's truth in what Compartamos says: It's costly to make and service small loans to poor people. And industry leaders say they need to charge more than what a typical bank in a developed nation would charge for a small-business loan. If they can't charge enough to cover their costs—much less generate profits, for those that seek them—they won't be able to stay in business.

Lenders Signing Up

By the time the new initiative was announced, more than 15 sizable microcredit organizations had signed statements endorsing it. The roster included Grameen and BRAC, big Bangladeshi organizations, and SKS Microfinance, a fast-growing, for-profit outfit in India. "We're very supportive of transparent pricing. It's part of treating your customers fairly," says Vikram Akula, SKS' chief executive. SKS already complies with the standards laid out by MicroFinance Transparency. Its rates vary from 24% to 28% on a declining basis, and the APR terms are spelled out on each borrower's record book. Akula predicts that most microfinance institutions will comply.

Some industry watchers are calling for even more extensive checks and balances. "Transparent pricing should apply to all financial services, not just loans," says Elizabeth Littlefield, chief executive of the Consulting Group to Assist the Poor. "Many poor people are aggressively sold multiple, expensive insurance policies, or are paying excessive fees for remittances." Still, she says of microcredit transparency: "We applaud the effort."

Hamm is a senior writer for BusinessWeek in New York and author of the Globespotting blog.