Promo%ng Transparent Pricing in the Microfinance Industry SESSION 2 The Price and Cost Curves Paris July 2012 Agenda 1. 
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Review recent challenges in microfinance Introduc=on to the confusing world of micro-­‐credit pricing Averages are decep=ve in microfinance! To understand microfinance, you need to understand “the curve” Transparent pricing is necessary to make the flawed market of micro-­‐credit func=on beMer Two common ques=ons without simple answers: 1) What is the “market price” of microcredit? 2) What is a “responsible price” for microcredit? Average Price Too High! Responsible Pricing Range Too Low! Is there a curve in other countries? The interes=ng ques=on: Are ins=tu=ons “off-­‐of-­‐the-­‐
curve” pricing responsibly? Why is there a price curve for micro-­‐loans? Are there cost curves in real data? Cost Components that Affect Pricing Component Financial Costs Loan Loss Opera=ng Costs Profit 10% 2% 20% 3% Total Price 35% In the Philippines, we find a curve not only for prices, but also for Opera=ng Costs. Common industry benchmark of 15-­‐20% OpCost Ra=o is appropriate for larger loans But smaller loans generate an Op Cost Ra=o well in excess of 20% No=ce that in all three countries there is a remarkably consistent spread between OCR and Yield Understanding the cost curve for micro-­‐loans Efficiency: Opera=ng Cost Ra=o The formula for the ra=o: Annual Opera=onal Cost -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ Average Loan Por[oliio We will analyze at the level of a single loan •  Cost to process and disburse a loan (once per loan) •  Monitoring cost (monthly cost) •  We annualize these cost Pricing for Different Products Component $100 Loan $1000 Loan Financial Costs Loan Loss Opera=ng Costs Profit 10% 2% 50% 3% 10% 2% 15% 3% Total Price 65% 30% Responsible Behavior is an Obliga=on •  Microfinance take place in quite imperfect markets •  Our clients are the very poor •  We hold power, with power comes responsibility •  Micro-­‐credit is not an exchange nego=ated between equal par=es 3.  The tempta=on of large profits can lead some to irresponsible prac=ce 4.  Irresponsible prac=ce leads to client abuse 5.  This repeats the paMern of the past 2,000 years. Microfinance was created to be an alterna=ve path. The Income Distribu=on Pyramid How much weath should be transferred from the poor to the rich? Microfinance is a rare industry with nearly 100% of clients at boMom of the pyramid. Individual Lending Solidarity Groups Village Banking Self-­‐Help Groups How shall we discuss fairness and ethics? Defining a Responsible Price MFI’s Costs Defining a Responsible Price MFI’s Costs + MFI’s Choice of Profit Defining a Responsible Price MFI’s Costs + MFI’s Choice of Profit = Price Set by the MFI Defining a Responsible Price MFI’s Costs + MFI’s Choice of Profit = Price Set by the MFI What Price Can the Poor Afford? Defining a Responsible Price MFI’s Costs Step 1: Cost Curve and Choice of Profit Level + MFI’s Choice of Profit = Price Set by the MFI Step 2: Analysis or current product-­‐level prices What Price Can the Poor Afford? Step 3: Factors influencing client ability to pay Pricing for Sustainability must address the reality of the COST curve Mexico, Brazil, and Colombia not present at 100% Only Mexico, Brazil, Colombia and Philippines at 5% Operating Cost Ratio, average per county data
GNI/Cap Mexico
5%
50%
10%
33%
25%
20%
50%
100%
150%
200%
Brazil
60%
35%
24%
19%
Colombia
55%
28%
18%
12%
Philippines Azerbaijan
60%
32%
21%
22%
17%
16%
14%
12%
12%
10%
Operating Cost Ratio, average per county data
GNI/Cap Ecuador
5%
10%
25%
25%
15%
50%
10%
100%
7%
150%
200%
Nepal
13%
8%
5%
Bosnia
15%
11%
7%
Bolivia
25%
17%
14%
13%
12%
Bulgaria
16%
12%
8%
7%
6%
Average
58%
28%
18%
13%
9%
10%
9%
Price curve follows cost curve Price curve follows cost curve A new way to look at the data 1. 
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Is an MFI close to the curve in its country for costs? For por[olio yield? If not, why not? What spread has the MFI selected between its costs and the price it has chosen? Pricing for Sustainability Pricing for Profits A Deeper Discussion of “Sustainability” The Ins=tu=on •  Must the ins=tu=on be sustainable? A Deeper Discussion of “Sustainability” The Ins=tu=on •  Must the ins=tu=on be sustainable? Each loan product •  Must each product be sustainable? •  Fair for the rich to subsidize the poor? •  Fair for the poor to subsidize the rich? A Deeper Discussion of “Sustainability” The Ins=tu=on •  Must the ins=tu=on be sustainable? Each loan product •  Must each product be sustainable? •  Fair for the rich to subsidize the poor? •  Fair for the poor to subsidize the rich? Each client within a loan product •  Must each individual loan be sustainable? •  Fair for some clients to subsidize others? The Profit/(Loss) Component is the Choice of Management Pricing for Profits Pricing for Profits Pricing for Profits Proposal Let’s embrace a respec[ul and serious dialogue on these issues of prices and profits What do YOU think? If your MFI is new, and your costs are therefore high, is it fair to set a high price and hide it from your clients? What do YOU think? If the market is compe==ve for $2000 loans, is it fair to make high profits from $200 loans to subsidize the $2000 loans? What do YOU think? What is the maximum ROA that is fair for $5000 loans? A) 2% B) 5% C) 10% D) 20% E) no limit What do YOU think? What is the maximum ROA that is fair for $200 loans? A) 2% B) 5% C) 10% D) 20% E) no limit Promo=ng Transparent Pricing in the Microfinance Industry