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  • Consumer Protection and Microfinance

    Country Reports

    Legal Empowerment Working Paper Series

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    Consumer Protection and Microfinance

    Country Reports

    Legal Empowerment

    Working Paper Series

  • Consumer Protection and Microfinance: Country Reports

    Copyright International Development Law Organization 2011

    International Development Law Organization (IDLO)

    IDLO is an intergovernmental organization that promotes legal, regulatory and institutional reform to advance economic and social development in transitional and developing countries. Founded in 1983 and one of the leaders in rule of law assistance, IDLO's comprehensive approach achieves enduring results by mobilizing stakeholders at all levels of society to drive institutional change. Because IDLO wields no political agenda and has deep expertise in

    different legal systems and emerging global issues, people and interest groups of diverse backgrounds trust IDLO. It has direct access to government leaders, institutions and multilateral organizations in developing countries, including lawyers, jurists, policymakers, advocates, academics and civil society representatives.

    Among its activities, IDLO conducts timely, focused and comprehensive research in areas

    related to sustainable development in the legal, regulatory, and justice sectors. Through such research, IDLO seeks to contribute to existing Practice and scholarship on priority legal issues, and to serve as a conduit for the global exchange of ideas, best practices and lessons learned. IDLO produces a variety of professional legal tools covering interdisciplinary thematic and regional issues; these include book series, country studies, research reports, policy papers, training handbooks, glossaries and benchbooks. Research for these publications is conducted

    independently with the support of its country offices and in cooperation with international and national partner organizations.

    DONOR SUPPORT

    This research is part of the IDLOs "Legal Empowerment Program" and is being funded by the Bill &

    Melinda Gates Foundation (http://www.gatesfoundation.org). The findings and conclusions contained

    within are those of the authors and do not necessarily reflect the positions or policies of the Bill & Melinda Gates Foundation.

    Disclaimer

    IDLO is an intergovernmental organization and its publications are intended to expand legal knowledge, disseminate

    diverse viewpoints and spark discussion on issues related to law and development. The views expressed in this

    Publication are the views of the authors and do not necessarily reflect the views or policies of IDLO or its Member States.

    IDLO does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any

    consequence of its use. IDLO welcomes any feedback or comments regarding the information contained in the

    Publication.

    All rights reserved. This material is copyrighted but may be reproduced by any method without fee for any educational purposes, provided that the source is acknowledged. Formal permission is required for all such uses. For copying in other

    circumstances or for reproduction in other publications, prior written permission must be granted from the copyright

    owner and a fee may be charged. Requests for commercial reproduction should be directed to the International

    Development Law Organization.

    Cover picture Heres Kate

    Published by:

    International Development Law Organization Viale Vaticano, 106

    00165 Rome, Italy

    Tel: +39 06 4040 3200 Fax: +39 06 4040 3232

    www.idlo.int idlo@idlo.int

    http://www.gatesfoundation.org/

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    Table of Contents

    List of Acronyms .............................................................................................. 8

    Introduction ............................................................................................. 11

    India Country Report ................................................................................. 13

    1. Introduction ............................................................................................. 13

    1.1 Country Overview ......................................................................... 14

    1.2 Consumer Protection in Indias Financial Services Sector ................... 15

    1.3 Microfinance Institutions ................................................................ 16

    1.4 Microfinance in the News ............................................................... 18

    2. Protection of the Financial Consumer in Indian Legislation and Regulation ....... 20

    2.1 Transactional Regulation ................................................................ 20

    2.1.1 Regulatory Framework for Financial Contracts ..................... 20

    2.1.2 Key Contractual Terms ...................................................... 21

    2.2 Non-transactional Regulation ......................................................... 22

    2.2.1 Data Regulation .............................................................. 22

    2.2.2 Use of Agents ................................................................. 23

    2.2.3 Advertising ..................................................................... 23

    2.3 Supervision and Enforcement ........................................................ 24

    3. Field Research .......................................................................................... 25

    3.1 Methodology Research Design ..................................................... 25

    3.2 Microfinance Institutions ................................................................ 27

    3.2.1 Assessment of Customers Ability to Repay ......................... 28

    3.2.2 Use of Client Information .................................................. 28

    3.2.3 Information Provided to Consumers .................................... 28

    3.2.4 Debt Collection Practices ................................................... 28

    3.2.5 Redress Mechanisms for Consumer Complaints ................... 29

    3.3 Clients ........................................................................................ 30

    3.3.1 Client Selection of MFIs .................................................... 30

    3.3.2 Requirements for Receiving Credit ...................................... 32

    3.3.3 Information on Contract Terms and Conditions .................... 32

    3.3.4 Consequences of Late Payment .......................................... 33

    3.4 Ombudsmen ................................................................................ 34

    3.4.1 Disputes ......................................................................... 34

    3.4.2 Procedures ..................................................................... 35

    3.4.3 Awards and Enforcement................................................... 35

    3.4.4 Content and Clarity of Financial Contracts ........................... 36

    3.4.5 Other Recourse and Applicability to Microfinance ................. 36

    4. Recommendations ..................................................................................... 37

    Annex I Regulatory Framework for Relevant Subjects ...................................... 39

    Annex II Form of Complaint (to be lodged) with the Banking Ombudsman .......... 43

    References .................................................................................................... 45

    Colombia Country Report ........................................................................... 47

    1. Introduction ............................................................................................. 47

    2. Protection of the Financial Consumer in Colombian Legislation and Regulation .. 48

    2.1 Consumer Protection in Colombias Financial Services Sector ............. 48

    2.2 Financial Consumer Protection: A Legal and Regulatory Overview ....... 50

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    2.3 Consumer Protection in Transactional Regulation .............................. 51

    2.3.1 Financial Contracts ........................................................... 51

    2.3.2 Credit Conditions .............................................................. 52

    2.3.3 Guarantees ..................................................................... 53

    2.3.4 Savings Deposits .............................................................. 53

    2.4 Consumer Protection in Non-transactional Regulation ........................ 54

    2.4.1 Credit Risk Analysis .......................................................... 54

    2.4.2 Non-bank Correspondents ................................................. 55

    2.5 Supervision and Enforcement ........................................................ 55

    3. Field Research .......................................................................................... 56

    3.1 Methodology Research Design ..................................................... 56

    3.2 Microfinance Institutions (MFIs) ...................................................... 58

    3.2.1 Assessment of Clients Ability to Repay ............................... 59

    3.2.2 Information on Interest Rates and Payments ....................... 60

    3.2.3 Collection Practices ........................................................... 60

    3.2.4 Consumer Complaint Mechanism ........................................ 60

    3.2.5 Use of Client Information .................................................. 60

    3.3 Clients ........................................................................................ 60

    3.3.1 Choice of Microfinance Institution ....................................... 61

    3.3.2 Credit Application Requirements ......................................... 62

    3.3.3 Knowledge of Contract Terms and Conditions ...................... 62

    3.3.4 Consequences of Late Payment .......................................... 63

    3.4 Judiciary ..................................................................................... 65

    3.4.1 Recurring Controversies Between MFIs and Customers ......... 65

    3.4.2 Probable Causes of Process Delay....................................... 66

    3.4.3 Defence Capability of Financial Consumers .......................... 66

    3.4.4 Content and Clarity of Financial Contracts ........................... 67

    4. Conclusions and Recommendations ............................................................. 67

    4.1 Conclusions ................................................................................. 67

    4.1.1 Regulatory Framework ...................................................... 67

    4.1.2 Regulatory Gaps .............................................................. 68

    4.1.3 Effective Application of the Regulatory Framework ............... 68

    4.1.4 Gaps Between Law and Practice ......................................... 69

    4.2 Recommendations ....................................................................... 69

    References .................................................................................................... 72

    Kenya Country Report ................................................................................ 73

    1. Introduction ............................................................................................. 73

    1.1 Country Overview ......................................................................... 73

    2. Protection of the Financial Consumer in Kenyan Legislation and Regulation ..... 75

    2.1 Financial Consumer Protection: A Legal and Regulatory Overview ....... 75

    2.2 The Institutional Framework........................................................... 76

    3. Field Research .......................................................................................... 76

    3.1 Contracting and Disclosure Practices ............................................... 77

    3.1.1 Commercial Practices of MFIs and Informational Asymmetries 77

    3.1.2 Advertising and Price Display ............................................. 78

    3.1.3 Contracts ........................................................................ 79

    3.1.4 Interest Rate Disclosure .................................................... 81

    3.2 Collateral in Kenyan Microfinance.................................................... 81

    3.2.1 Typology of Microfinance Collateral ..................................... 81

    3.2.2 The Issue of Blocked Deposits ............................................ 83

    3.2.3 Collateral Regulation 1: The Protection of the Borrower ......... 83

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    3.2.4 Collateral Regulation 2: Inefficiencies ................................. 84

    3.3 Debt Collection and Judicial Procedures .......................................... 85

    3.3.1 The Role of Chiefs ............................................................ 86

    3.3.2 Auctioneers ..................................................................... 86

    4. Conclusions and Recommendations ............................................................. 87

    References .................................................................................................... 89

    Cameroon Country Report .......................................................................... 90

    1. Introduction ............................................................................................. 90

    1.1 Country Overview ......................................................................... 90

    2. Protection of the Financial Consumer in Cameroonian Legislation and Regulation ..

    ............................................................................................................... 90

    2.1 Civil Law in Cameroon ................................................................... 92

    2.2 Common Law and Customary Law .................................................. 92

    2.3 International Law 1: OHADA Law .................................................... 92

    2.4 International Law 2: CEMAC/UMAC/COBAC Law ................................ 93

    2.5 The Directorate of Consumer Protection ........................................... 94

    2.6 Bank of Central African States (BEAC) ............................................ 95

    3. Field Research .......................................................................................... 95

    3.1 Informational Asymmetries ............................................................ 96

    3.2 Advertising, Price Display and Sales Practices ................................... 97

    3.3 The Formal Requirements of Financial Contracts ............................. 100

    3.4 The Notion of Public Order ........................................................... 103

    3.5 Interest Rate and Usury .............................................................. 104

    3.5.1 Observed Interest Rates ................................................. 104

    3.5.2 A Market Interest Rate? ................................................. 104

    3.6 Array of Security Interests in Cameroonian Microfinance .................. 105

    3.6.1 Security Interests: Authentic Pledges and False Mortgages .. 105

    3.6.2 Personal Security ........................................................... 106

    3.6.3 Other Forms of Security .................................................. 106

    3.6.4 Registration and Inscription ............................................. 107

    3.6.5 Over-collateralisation ...................................................... 109

    3.7 Redress Mechanisms ................................................................... 109

    3.7.1 The Low Frequency of Cases ............................................ 110

    3.7.2 Elements of Proceedings ................................................. 110

    3.7.3 The Outcome of Legal Procedures .................................... 111

    3.7.4 The Unsuitability of the Formal Justice Machinery in

    Microfinance Operations .................................................. 111

    4. Conclusion: Recommendations for Strengthening Consumer Protection .......... 112

    References .................................................................................................. 114

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    List of Acronyms

    ADR Alternative Dispute Resolution

    AER Annual Equivalent Rate

    AML Anti-Money Laundering

    APR Annual Percentage Rate

    BAFIA Banking and Financial Institutions Act (BAFIA) 1989

    BANCOLDEX International Commerce Bank of Colombia

    BC Banking Correspondent

    BCSBI Banking Codes and Standards Bureau of India

    BEAC Banque des Etats dAfrique Centrale (Bank of Central

    African States)

    BPLR Benchmark Prime Lending Rate

    CBK Central Bank of Kenya

    CEMAC Communaut Economique et Montaire dAfrique Centrale

    (Economic and Monetary Community of Central Africa)

    CEO Chief Executive Officer

    CFT Combating Financing of Terrorism

    CGT Continuous Group Training

    CIBIL Credit Information Bureau India Limited

    CIMA Confrence Interafricaine des Marchs d'Assurances

    (Inter-African Conference on Insurance Markets)

    CNC Conseil National du Crdit (National Credit Council)

    COBAC Commission Bancaire dAfrique Centrale (Banking

    Commission of Central Africa)

    CPA Consumer Protection Act, 1986

    CRB Credit Reference Bureau

    CRMS Credit Risk Management System

    DANSOCIAL Administrative Department of Supportive Economy

    DICGC Deposit Insurance Credit Guarantee Corporation

    FIs Financial Institutions

    FOGAFIN Financial Institutions Guarantee Fund

    FOGAMIC Fond de garantie des dpts des EMF (Deposit Guarantee

    Fund of MFIs)

    FSA Financial Services Authority

    FSD Financial Sector Deepening. FSD Kenya is an independent

    Trust established to support the development of inclusive

    financial markets in Kenya.

    FTC Federal Trade Commission

    GDP Gross Domestic Product

    GRT Group Recognition Test

    IBC Current Bank Rate

    ICA Investment Climate Assessment

    ICETEX Colombian Institute for Educational Credit and Technical

    Studies Abroad

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    IDLO International Development Law Organization

    IPO Initial Public Offering

    KBA Kenya Bankers Association

    KRA Kenya Revenue Authority

    KSH Kenyan Shillings

    KUSCCO Kenya Union of Savings and Credit Cooperative

    Organizations

    KYC Know Your Customer

    LMMW Legal Monthly Minimum Wage

    M-CRIL Micro-Credit Ratings International Limited

    MFI Microfinance Institution

    MFIN Microfinance Institutions Network

    MHCP Ministry of Finance and Public Credit

    MINFI Ministry of Finance

    MIPYMEs Micro, Small, and Medium Enterprises

    MSCA Multi-State Cooperative Societies Act, 2002

    NABARD National Bank for Agriculture and Rural Development

    NBC Net Bank Credit

    NBFC Non-Banking Finance Company

    NCA National Credit Act

    NGO Non-Governmental Organisation

    OFT Office of Fair Trading

    OHADA Organisation pour l'Harmonisation en Afrique du Droit des

    Affaires (Organization for the Harmonisation of Business

    Law in Africa)

    PARIF Plan dActions en vue du Renforcement de

    lIntermdiation Financire au Cameroun (Action Plan for

    the Strengthening of Financial Intermediation in

    Cameroon)

    PESF Programme d'Evaluation du Secteur Financier (Financial

    Sector Assessment Programme)

    RBI Reserve Bank of India

    RCCM Registre du Commerce et du Crdit Mobilier (Trade and

    Real Estate Credit Register)

    RETSAS Registry of Interest Rates, Fees and Other Costs

    RIDF Rural Infrastructure Development Fund

    RLA Registered Land Act (Cap. 300 Laws of Kenya)

    RRB Regional Rural Bank

    RTA Registration of Titles Act (Cap. 281 Laws of Kenya)

    SACCO Saving and Credit Cooperative

    SAFC System for Attending to the Financial Consumer

    SF Superintendence of Finance

    SHG Self Help Group

    SIDBI Small Industries Development Bank of India

    TEG Taux Effectif Global (Percentage Rate of Charge)

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    TILA Truth in Lending Act

    TPI Tribunal de Premire Instance (Court of First Instance)

    VAT Value Added Tax

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    INTRODUCTION

    IDLO has five years of experience in studying and providing training on legal and

    regulatory frameworks for microfinance. Building on this experience, IDLO initiated

    and carried out a series of research projects on approaches to consumer protection

    in the microfinance industry in four countries: Cameroon, Colombia, India, and

    Kenya. The following reports combine review of law and regulation with empirical

    findings on actual practices. It is hoped that the results will inform the search for

    principles of good practice and regulation.

    In a World Bank working paper entitled Good Practices for Consumer Protection and

    Financial Literacy in Europe and Central Asia: A Diagnostic Tool, the authors wrote

    that until the financial crisis of 2007-2009, an estimated 150 million new consumers

    in financial services were being added to the global economy each year.1 The pace

    has slowed since then, but growth continues, especially in developing countries

    where consumer protection and financial literacy are still in their infancy. Particularly

    in countries that have transitioned from central planning to market economies,

    empowering consumers has become a prerequisite for efficient and transparent

    financial markets.2 The term consumer protection encompasses ensuring that

    consumers receive information that will allow them to make informed decisions, are

    not treated unfairly or deceived by unscrupulous firms, have access to recourse

    mechanisms to resolve disputes when transactions go awry and can maintain privacy

    of their personal information.

    In addition, the World Bank paper encourages financial literacy initiatives to provide

    consumers the knowledge, skills and confidence to understand and evaluate the

    information they receive and empower them to purchase those financial products

    and services which meet their needs and the needs of their families.3 Countries that

    establish consumer protection regulation and also promote financial literacy can

    establish clear rules of engagement between financial firms and their retail

    customersand help narrow the knowledge gap between consumers and their

    financial institutions. Thus, consumer protection regulation and financial literacy

    efforts are complementary, rather than alternative methods for achieving the long-

    term stability of a countrys financial market.

    The challenge for countries that want to create prudent consumer protection

    regulations is to strike the right balance between government regulation and market

    competitive forces. Government intervention should be considered, according to the

    World Banks recommendations, only when it is both feasible and cost-effective to do

    so. Rules need to be proactive to prevent abuses and not simply react to problems of

    the past. At the same time, care must be taken since regulation can stifle financial

    innovation. As noted by U.S Federal Reserve Board Chairman Ben Bernanke in April

    2009, regulators should strive for the highest standards of consumer protection

    without eliminating the beneficial effects of responsible innovation on consumer

    1 Rutledge, Susan L., Annamalai, Nagavalli, Lester, Rodney, Symonds, Richard L., Good Practices for Consumer Protection and Financial Literacy in Europe and Central Asia: A Diagnostic Tool, World Bank, August 2010. 2 Ibid. 3 Ibid.

  • 12

    choice and access to credit. To ensure that regulation is both effective and efficient,

    sound regulatory impact analyses should be conducted.4

    IDLO appreciates the assistance of the many persons and organizations, who

    provided data and experience, which informed this report.

    4 Ibid.

  • INDIA COUNTRY REPORT

    Matteo Mandrile*

    (Microfinance Research Officer, International Development Law Organization)

    Anthony Hazkial

    (Microfinance Researcher, International Development Law Organization)

    1. Introduction

    This Country Report summarizes the results of the research conducted in India by

    IDLO in partnership with Micro-Credit Ratings International Limited (M-CRIL).

    As financial inclusion is a public policy objective for the Indian government and the

    Reserve Bank of India (RBI), consumer protection regulation has recently taken

    center stage in the country. Moreover, Indias microfinance sector has been in the

    news headlines recently with reports that cited experts who warned of a looming

    crisis in Indias microfinance sector. IDLO has identified an urgent need to compile

    and analyze case law that can help establish legal precedence of consumer rights

    protection in the microfinance industry, specifically regarding microcredit (group and

    individual lending and guarantee agreements), and the actual implementation of

    these principles within the microlender-poor borrower relationship.

    This report first provides a background on the Indian microfinance market and the

    key players in consumer protection. The paper also examines the Indian legal and

    regulatory framework for consumer protection in microfinance, focusing on

    transactional and non-transactional regulation, supervision and enforcement. Finally,

    field research results are presented based on interviews and surveys of microfinance

    institutions (MFIs), borrowers, and ombudsmen.

    The MFIs that we interviewed represented regulated and unregulated entities with

    large loan portfolios of consumers throughout India. From each MFI, clients were

    then interviewed to gauge their perceptions about consumer protection. Finally,

    Banking Ombudsmen were interviewed so that accounts could be taken of their first-

    hand experiences in adjudicating consumer complaints in India. MFIs were also

    surveyed about how they selected clients and evaluated their ability to repay the

    loans. The researchers asked about disclosure procedures, as well as details

    regarding loan collections. Lastly, MFIs were asked about consumer complaints and

    redress mechanisms. This information was used along with client interviews to obtain

    the borrowers perceptions. Interviewing the Banking Ombudsmen helped to

    reinforce the themes that we heard during the MFI and client interviews. The

    Ombudsmen interviews also helped us to assess overall consumer protection and to

    develop recommendations to improve it.

    The authors would like to acknowledge the local research team from M-CRIL and IDLO contributors for

    their work in compiling this report. Alok Misra, Rohit Midha and Aleksandra J. Kasprzycka provided valuable assistance.

  • 14

    1.1 Country Overview

    India, with a population of more than 1.1 billion people, is the worlds second most

    populated country. Its population is mostly rural, with only 29% living in urban

    areas.1 About 65% of Indias total population is literate. The literacy rate, however,

    is much greater in Indias urban areas, 80.3%, compared to 59.4% in rural regions.2

    Even then, Indias gross domestic product (GDP) is roughly evenly distributed

    between rural and urban areas.3 GDP per capita was estimated at $3,100 in 2009,

    ranking the country 163rd in the world, and an estimated 25% of the population lives

    below the poverty line.4

    India is a sovereign, socialist, secular, democratic, republic5 state. Under its

    constitution, India strives to secure justice, liberty, and equality for all its citizens.6

    India is a federal republic comprised of 28 states and 7 union territories. The legal

    system is based on English common law and its legislation is subject to judicial

    review.7

    In line with the principles noted in the preamble to Indias constitution, some of

    Indias laws were drafted to promote economic justice and equality. For example, to

    increase financial access among low-income segments of the population, the Reserve

    Bank of India (RBI), Indias bank regulator, devised a policy of Priority Sector

    Lending requiring commercial banks, both domestic and foreign, to direct a certain

    percentage of their net bank credit (NBC) to low-income segments of the population.

    Such segments include: agriculture, small-scale industries, small road and water

    transport operators (owning up to 10 vehicles), small businesses, and state-

    sponsored organizations for scheduled castes/scheduled tribes (any of the historically

    disadvantaged Indian castes of low rank, now under government protection; the

    name is derived from the fact that these castes were entered on a list or "schedule"

    during British rule).8 Domestic scheduled9 commercial banks, public and private, that

    fail to achieve the priority sector lending targets are required to deposit into the

    Rural Infrastructure Development Fund (RIDF) (maintained by National Bank for

    Agriculture and Rural Development (NABARD) and used for rural infrastructure

    financing) such amounts as may be assigned by the RBI. If a foreign bank operating

    in India fails to achieve the Priority Sector Lending targets, an amount equivalent to

    the shortfall is required to be deposited with the Small Industries Development Bank

    of India (SIDBI) for one year, and the bank must pay a penalty of 8 percent interest

    per year.10

    1 Central Intelligence Agency (CIA), The World Factbook: India . 2 Ministry of Finance, Government of India, Economic Survey 2001-2002. 3 CIA, The World Factbook: India, supra note 1. 4 Ibid. 5 The Constitution of India, Preamble. 6 Ibid. 7 CIA, The World Factbook: India, supra note 1. 8 Reserve Bank of India, FAQs . 9 The commercial banking structure in India includes scheduled and unscheduled banks. Scheduled banks have been included in the Second Schedule of RBI Act, 1934. See: . 10 Reserve Bank of India, FAQs, supra note 8.

    http://rbi.org.in/scripts/NotificationUser.aspx?Id=3159&Mode=0.

  • 15

    1.2 Consumer Protection in Indias Financial Services Sector

    India enacted the Consumer Protection Act 1986 (CPA) that provides consumers with

    effective safeguards against exploitation and unfair dealing, relying mainly on a

    compensatory, rather than a punitive or preventative approach. The CPA applies to

    all goods and services, unless specifically exempted, including the private, public,

    and cooperative sectors and includes the provision of financial services. It also

    provides for speedy and inexpensive adjudication. Consumer Courts have been

    established under the CPA, and these judicial bodies make legal remedy available at

    the district, state and national levels. District court decisions may be appealed to the

    higher-level Consumer Protection Courts. Banks often appeal Consumer Courts

    rulings that are in favor of customers.

    As a prudential regulator, the RBI responds to consumer frauds that threaten the

    safety of Indias banking sector.

    The RBI has promulgated the Banking Ombudsman Scheme 2006. Under the

    scheme, a Banking Ombudsman is responsible for receiving and considering

    customer complaints relating to banking services. The Ombudsman facilitates the

    resolution of complaints through conciliation or mediation. Within the RBI, a separate

    Customer Service Department works in coordination with both the Banking

    Ombudsmen and the Banking Codes and Standards Bureau of India (BCSBI). The

    RBI has periodic meetings with banks Grievance Redressal Officers in order to

    analyze recurring complaints, complaint handling processes, and efforts to minimize

    complaints and improve consumer protection and overall satisfaction.

    The RBI introduced Banking Ombudsmen into the regulatory and consumer

    protection framework in 1995. India has 15 ombudsmen who act at an appellate

    level to address complaints and grievances that have not been resolved by the banks

    involved or that have not been addressed to the full satisfaction of the client.

    Banking Ombudsmen receive complaints from customers and can issue notices to

    banks involved. A conciliatory and consensual approach is adopted to resolve

    complaints, but Ombudsmen can also issue awards. Those awards are binding on

    banks unless they choose to appeal. If the appeal is dismissed, the decision or award

    is binding on the bank.

    The BCSBI, which includes 70 member banks and the RBI, is a voluntary industry

    body that was created to promote consumer protection issues. The BCSBI also

    advocates for banking standards and transparency. Among other initiatives, BCSBI

    has developed the Code of Banks Commitment to Customers and the Code of

    Banks Commitment to Medium and Small Enterprises. The BCSBI also operates a

    web-based hotline for client complaints which are managed through the RBI.

    Finally, microfinance institution (MFI) associations have developed and are

    promoting self-regulatory tools and best practices. One association is Sa-Dhan, a

    national network of community finance institutions, that has created standards of

    practice and a code of conduct for microfinance lenders. Members of another

    association, the Microfinance Institutions Network (MFIN), have also developed a

    code of conduct.

  • 16

    1.3 Microfinance Institutions

    MFIs provide financial services to low-income clients, who have traditionally lacked

    access to banking and related services. Microfinance institutions in India reached

    over 22 million borrowers and had a portfolio outstanding in excess of $2.3 billion as

    of March 2009, according to research conducted by Lok Capital.11.

    Most MFIs in India operate as registered societies or trusts. Cooperatives are also a

    common legal entity for MFIs. A growing trend is for MFIs to organize as not-for-

    profit companies under Section 25 of the Companies Act 1956. Some MFIs are also

    organized as non-bank financial companies (NBFC). While there are relatively few

    NBFCs, they have 80% of the microfinance market share.

    The RBI established Priority Sector Lending targets that include loans to MFIs. As a

    result, Indias commercial banks are an important source of microfinance funds. A

    bank is defined by the Banking Regulation Act 1949 as an organization accepting,

    for the purpose of lending or investment, deposits of money from the public,

    repayable on demand or otherwise, and withdrawal by cheque, draft, order or

    otherwise.12 Banks are mainly regulated by the Banking Regulation Act, 1949. The

    RBI is responsible for licensing and supervising banks, while bank deposits are

    insured by the Deposit Insurance Credit Guarantee Corporation of India (DICGC).

    As previously mentioned, most non-governmental organization (NGO)-MFIs are

    registered as societies under the Societies Registration Act 1860. To be legally

    registered as a society, the MFI needs to explicitly mention microfinance in its

    Memorandum of Association as an activity fulfilling the societys charitable purpose.

    The Societies Registration Act 1860 lacks specific provisions regarding the

    management of funds, but it is an established precedent in case law that a societys

    governing body acts as trustee of the funds. Thus, the governing body must manage

    the societys funds as a prudent person would manage his or her own property. Also,

    the Societies Registration Act 1860 does not have provisions regarding the

    maintenance or audit of accounts. To fill the regulatory void, various states have

    enacted independent laws with provisions for maintaining and auditing financial

    records and accounts. Under Section 45S of the Reserve Bank of India Act 1934,

    unincorporated bodies are not allowed to accept public deposits. This includes

    organizations registered under the Societies Registration Act 1860 such as non-

    governmental organization (NGO)-MFIs.

    Enforcement of the Societies Registration Act 1860 and of corresponding state acts is

    the responsibility of the Registrar of Societies in each state. With respect to the

    microfinance activities of a society, the Registrar has no responsibility for prudential

    regulation, financial performance or solvency. The Registrar can only intervene if

    there is a major dispute regarding the management of the society, or if the Registrar

    suspects fraud against the societys creditors or other unlawful or unauthorized

    activities.

    Some MFIs (known as trust MFIs) are registered under the Indian Trust Act 1882.

    The creator or author of the trust-MFI is an individual with the intention of providing

    financial services to the poor and underserved. The creator of the trust gathers the

    funds and deploys them to the trust for the benefit of the beneficiaries. Under

    11 Microfinance Industry in India, Lok Capital, March 2010. 12 Banking Regulation Act 1949 (India) s 5(b).

  • 17

    Section 9 of the Indian Trust Act 1882, any person capable of holding property may

    be a trust beneficiary. Typically the trustee of a trust MFI is a board or other

    governing body. Though certain rights and duties of trustees are designated in the

    Indian Trust Act 1882, no specific provision was made regarding the trusts

    management. Thus, the deed forming the trust often includes specific directions for

    the management of the trust and for the use and investment of the trusts funds.

    Also, the trust must maintain financial records and accounts that must be periodically

    audited. Like societies, trusts are unincorporated bodies and are not allowed to

    accept public deposits.

    When MFIs are established as not-for-profit companies pursuant to section 25 of the

    Companies Act 1956 (Section 25 Company), they enjoy all the privileges and are

    subject to all the obligations of a limited company, except in instances where certain

    exemptions apply. The basic exemptions for Section 25 Companies relate to paying

    income tax and appointing a company secretary. More importantly for MFIs, sections

    45IA and 45IC of the Reserve Bank of India Act 1934 do not apply to Section 25

    Companies. Accordingly, MFIs registered as Section 25 Companies can engage in

    microfinance activity without registering with the RBI or obtaining its permission;

    microfinance activity is limited to business loans up to Rs 50,000 and home loans up

    to Rs 125,000. Section 25 Companies are not allowed to accept deposits.

    Another legal form used by some MFIs is the NBFC. An NBFC is a company registered

    under the Companies Act 1956 (but not under Section 25 of the Companies Act), and

    is engaged in the business of loans and advances, leasing, hire-purchase, insurance,

    chit business, or the acquisition of shares, stock, bonds, debentures, or other

    securities issued by the government or local authority or other securities of like

    marketable nature. However, NBFCs do not include any institution whose principal

    business consists of agriculture activity, industrial activity, or the sale, purchase or

    construction of immovable property.13 Thus, any company that undertakes

    microfinance activities, but is not registered as a Section 25 Company, qualifies as a

    NBFC and all related regulations apply. The regulations include registration with the

    RBI, imposition of prudential norms and compulsory credit rating of deposit-taking

    NBFCs.

    As companies, NBFCs are subject to the provisions of the Companies Act 1956. The

    provisions include laws relating to the board of directors, share capital, management

    structure, meetings, and maintenance and audits of financial records and accounts.

    In addition, NBFCs must comply with RBI regulation. Specifically, NBFCs holding or

    accepting public deposits are required to comply with all RBI directives on

    acceptance of public deposits and prudential norms, and have to submit periodic

    reports to the RBI.14 Further, after operating for a minimum of two years, an NBFC

    that wants to accept deposits must obtain an investment-grade rating from an

    approved credit rating agency at least once a year.15

    The RBI, in conjunction with the Registrar of Companies, is responsible for licensing

    and supervising NBFCs. In case of consumer fraud, abuse or complaint, the RBI, as

    13 Reserve Bank of India, FAQs, supra note 8. 14 Reserve Bank of India, Non-Bank Financial Companies in India (2001) ch V. 15 A NBFC allowed to accept deposits is prohibited from accepting demand deposits. Deposits must be held for a minimum of 12 months and a maximum of 60 months from acceptance or renewal. NBFCs cannot pay more than 11% interest on deposits, and interest shall not be paid or compounded more often than monthly. NBFCs cannot pay more than 2% of the amount deposited as a commission or other incentive to a broker.

  • 18

    well as the Economic Offences wing of the Central Bureau of Investigation, will

    respond. Deposits at an NBFC are insured by the Deposit Insurance and Credit

    Guarantee Corporation, but only up to Rs 5,000 per depositor.

    Cooperative banks and other cooperative societies in India are also undertaking

    microfinance activity. Specifically, MFIs are operating as primary cooperative banks.

    Under the Banking Regulation Act 1949, a primary cooperative16 bank is a primary

    credit society (other than a primary agricultural credit society) that mainly

    undertakes banking business, has paid-up capital and reserves of at least Rs

    100,000, and does not permit admission of any other cooperative society as a

    member. Primary cooperative banks are registered under the Cooperative Societies

    Act 1912, or under any other cooperative society law in force in any Indian state.

    Cooperative banks with a multi-state presence register under the Multi-State

    Cooperative Societies Act (MSCA) 2002.

    Cooperative banks are subject to state and federal licensing and supervision. On the

    state level, they are licensed through the Registrar of Cooperative Societies, and at

    the federal level by the RBI.17 Likewise, for urban cooperative banks, supervision

    occurs at the state level by the Registrar of Cooperative Societies and at the federal

    level by RBI. However, non-urban cooperatives are supervised by NABARD.18 The

    Registrar of Cooperative Societies is responsible for dealing with cases of consumer

    fraud. Deposits at a credit cooperative are not insured.

    As demonstrated, microfinance in India can take many forms and have numerous

    applicable regulations and responsible regulators. However, in the case of societies,

    trusts, and Section 25 Companies, microfinance activity is largely unregulated and

    unsupervised.

    1.4 Microfinance in the News

    Indias microfinance sector was featured in major news articles in recent months.

    The news initially held promise of a maturing and growing industry, but recent

    developments include warnings of a crisis in Indias microfinance sector.

    In July 2010, news of the initial public offering (IPO) of SKS Microfinance, the

    countrys first publicly owned and traded MFI, was featured in Indian and global

    news outlets. The development was a sign of the industrys maturity and growth, but

    it did not come without controversy.

    Some experts argued that microfinances mission to lift people out of poverty

    was incompatible with the objectives of a publicly traded company, which is to earn a

    profit for shareholders. In opposition to the IPO, Dr. Muhammad Yunus, 2006 Nobel

    Peace Prize Laureate and founder of Grameen Bank, was quoted as saying, by

    offering an IPO, you are sending a message to the people buying the IPO (that)

    there is an exciting chance of making money out of poor people. This is an idea that

    16 The term urban co-operative banks (UCBs) refers to primary cooperative banks located in urban and semi-urban areas. Until 1996 these banks were allowed to lend money only for non-agricultural purposes. This distinction does not hold today. These banks were traditionally centered around communities, localities work place groups. They essentially lent to small borrowers and businesses. Today, their scope of operations has widened considerably. Source: Reserve Bank of India, at . 21 Reserve Bank of India, Report of the Task Force to Study the Cooperative Credit System and Suggest Measures for its Strengthening (2000) ch II; see also Banking Regulation Act 1949 (India). 18 Ibid.

    http://www.rbi.org.in/scripts/fun_urban.aspx

  • 19

    is repulsive to me. Microfinance is in the direction of helping the poor retain their

    money rather than redirecting it (to) the direction of rich people.19 The conversation

    continued between Dr. Yunus and SKS founder and Chairperson, Mr. Vikram Akula,

    at a special session of the 2010 annual meeting of the Clinton Global Initiative. Mr.

    Akula argued that an IPO was the only way to access enough capital to be able to

    reach the more than 3 billion people who need access to microfinance. Dr. Yunus

    rebutted that microfinance should be considered as a separate service that is distinct

    from banking, and as such, MFIs should work toward deposit mobilization in order to

    enable them to become self sustaining.20

    Unfortunately, the recent microfinance news emerging from India has turned

    negative. In early October 2010, SKSs CEO was forced to resign. Later that month,

    Indian microfinance news developments were dominated by reports of a wave of

    suicides in the state of Andhra Pradesh that many blamed on MFIs heavy-handed

    collection practices. The suicides, as many as 56 in 60 days, triggered a political

    crackdown in Andhra Pradesh that resulted in an emergency ordinance requiring all

    MFIs in the state to register, and prohibiting loan collectors from visiting peoples

    homes.21 The controversy and crackdown has led commercial banks to freeze their

    MFI funding, and MFIs are now suffering from a liquidity crisis that may have ripple

    effects throughout Indias financial, and particularly microfinance, industry.22

    In response to the current crisis, the head of MFIN, a group of 44 of India's largest

    microfinance companies, is asking the RBI to step in and regulate them in place of

    Andhra Pradeshs government. Currently, the RBI oversees only those MFIs that are

    registered as NBFCs. NBFCs cover 80 percent of the microfinance market by loan

    volume, but constitute a small percentage of the total number of India's microfinance

    lenders.23Alok Prasad, MFINs chief executive, said that registered microfinance

    companies are not the problem. Instead, he blames the hundreds of unregulated

    MFIs. Mr. Prasad met with RBI officials to urge them to assert themselves as the sole

    regulator of the industry, and he was quoted by news outlets as saying, "The central

    bank understands what we are doing, but the Andhra Pradesh state government

    doesn't."24

    The central bank encourages commercial banks to lend to MFIs by classifying them

    as a Priority Sector. However, earlier in 2010, the RBI ordered a panel to examine

    whether the priority sector designation should be revoked. That question is likely to

    be explored by a subcommittee formed in the wake of the current crisis to broadly

    examine microfinance oversight.25

    Only one day after the Andhra Pradesh government passed its emergency ordinance,

    the RBI established a subcommittee of its board to investigate the issues concerning

    19 E Kinetz, SKS Launches India's First Microfinance IPO, The Associated Press, 28 July 2010. 20 Clinton Global Initiative, Annual Meeting Special Session: Profiting from the Poor? A Discussion on Microfinance IPOs (2010) ; summarized at . 21 E Kinetz, Indian microfinance warns of crisis after suicides, The Associated Press, 28 October 2010. 22 A Kazmin, Microfinance warns of collapse over credit freeze, Financial Times, 26 October 2010. 23 Ibid. 24 E Kinetz, Indian microfinance warns of crisis after suicides, supra note 21. 25 Ibid.

  • 20

    the microfinance sector.26 For example, the MFIs supported by commercial banks

    priority lending were not engaged in capacity building and empowerment of the

    loan groups. Many MFIs were in fact disbursing loans to newly formed groups within

    two weeks of their formation. The Self Help Group (SHG) Bank linkage program

    sponsored by the government recommends that a new group should spend six

    months for forming a group and nurturing it before accepting a microcredit loan.

    2. Protection of the Financial Consumer in Indian Legislation and

    Regulation

    2.1 Transactional Regulation

    2.1.1. Regulatory Framework for Financial Contracts

    In India, in line with common law principles, financial contracts are generally not

    required to be in writing.27 As such, no specific format or language is required and

    oral financial contracts will be enforced if proven before a court of law.28 Even if a

    contract is in writing, the contract is not required to be written in plain language.

    Also, financial services providers are not required to give the client a copy of the

    written contract.

    Conversely, financial institutions regulated by the RBI must adhere to the Fair

    Practices Code. Under the Code, the loan agreements should be in writing and

    conveyed to the borrower.29 Also, if a loan application is denied, the lender should

    communicate the reasons for the denial in writing.30 Institutions that are regulated

    and supervised by the RBI are also required to adopt the Fair Practices Code.

    Apart from restrictions on a minors ability to contract, Indian law does not hold a

    person incompetent to contract based on gender, age or literacy. Nor does Indian

    law require a cooling off period when contracting for financial services. Indian law

    requires that parties give free consent to form a contract.31 Where consent was not

    given freely, but instead was granted because of fraud, misrepresentation, coercion,

    or undue influence, the contract is voidable.32 Furthermore, Indian law provides that

    a contract is void if its object or purpose, even in part, is unlawful.33 Perhaps most

    importantly for consumers, who often lack bargaining power, a contract cannot

    restrict a partys ability to seek legal recourse and cannot eliminate a partys

    liability.34

    India adheres to common law contract principles including offer and acceptance,35

    modification and novation, and breach and rescission.36 Likewise, performance of a

    26 P Krar and R Kumar, RBI puts microfinance players on notice, Economic Times, 16 October 2010. 27 Indian Contract Act 1872 (India) s 10. A notable exception is the negotiable instrument. Negotiable Instruments Act 1881 (India). 28 Specific Relief Act 1963 (India) s 10. 29 Reserve Bank of India, Guidelines on Fair Practices Code for Lenders, 6 March 2007 (citing Circular DBOD. Leg. No.BC. 104 /09.07.007/2002- 03 dated May 5, 2003); Reserve Bank of India, Master Circular - Fair Practices Code 2009. 30 Reserve Bank of India, Guidelines on Fair Practices Code for Lenders, 6 March 2007 31 Indian Contract Act 1872 (India) ss 13, 14, 19. 32 Ibid s 19; see Indian Contract Act 1872 (India) ss 15-18 for definitions of coercion, undue influence, fraud, and misrepresentation. 33 Ibid ss 23, 24. 34 Ibid s 28. 35 Ibid ch I. 36 Ibid ss 62, 73-75.

  • 21

    financial contract is governed by common law principles. These principles allow the

    financial institution to specify the time, place, and manner of repayment if agreed to

    by the client.37 Furthermore, under Indian law, a financial institution cannot

    unilaterally change the terms of a contract.38 A financial institution can, however,

    unilaterally forgive, in whole or in part, repayment of the loan, or extend the time for

    repayment.39

    2.1.2. Key Contractual Terms

    In addition to collecting the principal, Indian lenders are allowed to charge interest,

    commissions and fees.40 The interest rate charged can be fixed, variable or a

    combination of the two.41 In India, the Usurious Loans Act 1918 authorizes courts to

    re-write the terms of an agreement when, based on its judgment, the interest rate

    charged is excessive. However, the Usurious Loans Act does not apply to banking

    companies and other financial institutions that are subject to the Banking Regulation

    Act 1949.42 Thus, the main purpose of the Usurious Loans Act is to protect borrowers

    who obtain credit from unregulated sources. This means, however, that many MFIs

    face the risk that courts may use the authority arising from the Usurious Loans Act

    1918 to reopen their transactions and change the interest rate charged.

    While the Usurious Loans Act does not apply to institutions subject to regulation

    under the Banking Regulation Act, the RBI has promulgated a Master Circular on

    Interest Rates on Advances, 2007. According to the Circular, regulated institutions

    must develop a Benchmark Prime Lending Rate (BPLR). The BPLR is determined by

    each institution after taking into account its (i) actual cost of funds; (ii) operating

    expenses; and (iii) a minimum margin to cover the regulatory requirements of

    provisioning, capital charge and profit margin. The BPLR is then the maximum

    interest rate allowable for credit advances up to and including Rs 200,000. For

    advances exceeding Rs 200,000, the institution is free to determine the interest rate

    charged. Certain transactions, however, are exempted from the above guidelines,

    regardless of their size. Exempted transactions include: (a) loans for purchases of

    consumer durables; (b) loans to individuals against shares and debentures or bonds;

    (c) other non-priority sector personal loans including credit card dues; and (d)

    finance granted to intermediary agencies for on-lending to ultimate beneficiaries and

    agencies providing input support. These exemptions are important, particularly

    because they include the situation where banks advance funds to MFIs for on-lending

    to ultimate beneficiaries.

    Regulated institutions are not allowed to charge penal interest rates (for defaults) on

    loans up to Rs 25,000 to priority sector borrowers. Also, for the purpose of improving

    price transparency, institutions are required to charge interest at monthly intervals,

    except for agricultural loans, where interest charges can be linked to the growing

    season. Lastly, according to the Circular, institutions should refrain from offering low

    or zero-percent interest rates on loans for consumer durables (made possible by the

    adjustment of manufacturer or dealer discounts) since such loans lack transparency

    37 Ibid ss 46-50. 38 Ibid s 62 (to alter the original contract requires the parties agreement). 39 Indian Contract Act 1872 (India) s 63. 40 Banking Regulation Act 1949 (India). 41 Ibid. 42 Ibid. s 21A (Notwithstanding anything contained in the Usurious Loans Act, 1918 (10 of 1918), or any other law relating to indebtedness in force in any State, a transaction between a banking company and its debtor shall not be re-opened by any court on the ground that the rate of interest charged by the banking company in respect of such transaction is excessive.).

  • 22

    and distort the pricing of loan products. Such products do not give the borrower a

    clear picture regarding the applicable interest rate.

    At the time of contracting, the lender must disclose to the borrower the monthly and

    annual nominal and effective interest rates as a percentage. Indian law also requires

    the lender to disclose all fees, including application, operational and administrative

    fees. Lenders must also disclose repayment terms, penalties for late payment and

    the acceleration terms. If applicable, lenders must also disclose any repayment

    holidays, gestation periods, taxes, and subsidies. 43

    In India, there are no legal limits to the amount that a lender can lend to a borrower.

    The law also does not limit the type of collateral that the lender can accept as

    security, but the collateral should be free from encumbrances.44 In the case of

    microfinance, there is no obligation to register the lenders security interest in the

    collateral due to small amounts of the loans.45 The customer retains possession of

    the collateral while repaying the loan; thus the asset remains productive. The

    customer, however, also bears the risk of any deterioration or diminution in the

    value of the collateral. The secured lender is not limited to the value of the collateral,

    but has the right to collect the entire principal amount of the loan and its interest.

    2.2 Non-transactional Regulation

    2.2.1. Data Regulation

    India lacks regulations that govern collecting, sharing, or selling business data.

    Typically, the financial institutions collect personal information, such as gender and

    address, and financial information about debts, but do not collect information about

    deposits, bill payments, rental payments, legal proceedings or bankruptcy.

    A model deposit policy guides banking secrecy in India. All products and services

    offered to individual customers are covered under banking secrecy practices.

    According to these practices, the banks shall not disclose the details of customers

    accounts to a third party without the customers express or implied consent.

    However, exceptions to this rule exist, such as when disclosure is compelled under

    the law, when there is a duty to the public, and if the interest of the bank requires

    disclosure.46

    India lacks a regulated credit bureau or a regulated central system to gather

    consumers business information. Nonetheless, there is a an unregulated credit

    bureau: the Credit Information Bureau India Limited (CIBIL).While unregulated,

    CIBIL conforms to ISO 27001: 2005, which means that it is certified in Information

    Security Standards. CIBIL currently collects only consumer and commercial borrower

    information that is reported by member institutions, but it intends to expand its

    coverage to include a broader range of information. CIBIL operates on the principal

    of reciprocity; only members who have shared all their information are able to obtain

    credit reports from CIBIL. Borrowers are also entitled to obtain copies of their own

    credit report. To correct discrepancies in their credit report, however, borrowers

    must contact the lender and request the necessary changes.47

    43 Banking Regulation Act 1949 (India). 44 Transfer of Property Act 1882 (India) ch IV. 45 Indian Registration Act 1908 (India) ss 17, 18. 46 Indian Banks Association, . 47 Credit Information Bureau India Limited (CIBIL), FAQs, .

  • 23

    2.2.2. Use of Agents

    In India, the financial institution-agent relationship is regulated as a common law

    principal-agent relationship. Therefore, if a financial institution employs an agent,

    known in India as a business correspondent (BC), whether as a service provider or to

    undertake collections, the financial institution is liable for the conduct of the BC. Due

    to the lack of a specific regulation, the operational and technical capacity required of

    a BC is governed principally by contract between the institution and the BC.

    Financial institutions need to be authorized by its regulator to appoint an agent.

    Once a financial institution obtains approval to appoint an agent, however, the

    supervisory authority does not approve individual agency relationships. Recently, the

    RBI has expanded the field of possible BCs to include individuals, NGOs, cooperative

    societies, post offices and companies with retail outlets.48 However, the RBI does not

    allow NBFCs to serve as BCs. Some people have suggested that NBFCs are restricted

    from serving as BCs because allowing them to mobilize deposits for banks while

    continuing their own lending operations may create a conflict of interest.49

    In other words, who may serve as a BC is mostly subject to the banks comfort level

    after completing their due diligence.50 Each bank is also responsible for instituting

    additional safeguards, as may be considered appropriate by the bank, to minimize

    the agency risks.51 These safeguards should protect confidentiality of customer

    information in the custody or possession of BCs.52 Also, banks should put in place a

    mechanism to redress grievances and display the details of this mechanism at the BC

    premises as well as at the base branch.53

    Agents in India are not expressly prohibited from providing any financial service, and

    they typically perform a wide range of services. According to the Circular on the use

    of BCs, to help ensure the viability of the BC model, BCs may offer a wide range of

    products and services including small savings, micro-credit, micro-insurance, and

    small value remittances.54 Despite the liberal guidelines, the BC model in India is

    struggling to be sustainable, mostly because of its high operating costs. The

    challenge for banks and BCs is to find the right product mix that will make business

    sense. Due to such challenges, many companies have stopped acting as a BC,

    choosing instead to focus on their core businesses.55

    2.2.3. Advertising

    India has no overarching law regulating the advertising practices of financial

    institutions. However, marketing practices are addressed in other ways, such as

    through the Fair Practice Codes. These regulations prohibit false indication about the

    48 A Roy and S Shankaran, RBI permits corporations to work as rural agents of banks, Mint, 29 September 2010, 1. 49 Ibid. 50 Reserve Bank of India, Circular on Financial Inclusion by Extension of Banking Services - Use of Business Correspondents (amendment) 2010. 51 Ibid. 52 Reserve Bank of India, Circular on Financial Inclusion by Extension of Banking Services - Use of Business Correspondents 2009. 53 Ibid. 54 Ibid; A Roy and S Shankaran, RBI permits corporations to work as rural agents of banks, supra note 48, 3. 55 Ibid.

  • 24

    supplied product or provided service, as well as false representations of material

    facts. These prohibitions apply not only to intentional misstatements and

    misrepresentations, but also to statements made recklessly. In its advertising, a

    financial institution is allowed to make fair comparisons between the quality, price, or

    terms and conditions of its product and the product of another provider.

    2.3 Supervision and Enforcement

    Before a secured creditor can collect against the collateral securing the defaulting

    loan, the creditor must petition a competent court to receive an order of attachment

    against the collateral. Likewise, an unsecured creditor must also petition a competent

    court to receive an order of attachment against the defaulting borrower. If a debtor

    has written an uncovered check (i.e., a bad check), the creditors only recourse is to

    file a lawsuit against the debtor for not honoring the check.

    To improve consumer protection, the RBI introduced the Banking Ombudsman

    Scheme in 1995 (now formulated in the Banking Ombudsman Scheme, 2006). The

    Scheme applies to all commercial banks, regional rural banks (RRBs) and scheduled

    primary cooperative banks. Its object is to enable the resolution of complaints

    relating to banking services and to facilitate the settlement of such complaints.

    Under the Scheme, any person may file a complaint with the Banking Ombudsman

    alleging a deficiency in banking services. While the Scheme lists various grounds for

    a complaint, the most commonly occurring types of complaint relate to levying of

    charges without adequate prior notice and non-observance of RBI guidelines on the

    engagement of recovery agents.

    To file a complaint with the Banking Ombudsman, the complainant must first make a

    written complaint to the bank. To facilitate this, banking institutions are required to

    place a complaint form on their website and clearly state how they should be

    contacted in case of a grievance. Only after the bank rejects the complaint or fails to

    respond within one month after receiving the complaint, or if the complainant is not

    satisfied with the banks reply, may the complainant file a complaint with the

    Ombudsman. In addition, the complaint must be filed with the Ombudsman within

    one year after receiving a reply from the bank, or within one year and one month

    from the date of the written representation to the bank in case the bank failed to

    reply. The form of the complaint is specified in Annex A of the Banking Ombudsman

    Scheme, and reproduced in Annex II of this report. The Scheme also provides that

    the Ombudsmen shall entertain complaints covered by the scheme which have been

    received by the Government of India or the RBI and which have been forwarded by

    them to the Ombudsman for resolution.

    The Ombudsman is responsible for promoting a settlement between the parties, and

    he may follow such procedures as he may consider just and proper and he shall not

    be bound by any rules of evidence.56 If the complaint is not settled with an

    agreement between the parties within one month, or such extra time as the

    Ombudsman may allow, then the Ombudsman may make an award or reject the

    complaint. The Ombudsman shall take into account the evidence placed before him

    by the parties, the principles of banking law and practice, directions, instructions and

    guidelines issued by the Reserve Bank from time to time and such factors which in

    his opinion are relevant to the complaint.57 The Ombudsman cannot issue an award

    56 Reserve Bank of India, The Banking Ombudsman Scheme 2006, s 11(2). 57 Ibid s 12(2).

  • 25

    directing the payment of an amount greater than the actual loss suffered, or Rs 1

    million, whichever is lower.

    Since May 2007, complainants as well as banks can appeal the decision of the

    Banking Ombudsmen to the Appellate Authority. Of the 251 appeals made in 2008-

    2009, the vast majority of appeals were lodged by complainants, while banks lodged

    18 appeals.58 This trend might suggest that consumers of banking services in India

    are increasingly aware of their rights and are willing to fight where they see

    deficiencies.

    The majority of the complaints (88%) received during 2008-2009 were received from

    individuals, and about a third of the complaints (32%) concerned private sector

    banks, which is part of an upward trend.59 The consumer grievances pertained

    mostly to credit cards, failures to meet commitments, and loans and advances.60

    Notably, during 2008-2009, there was a 65% increase in the number of complaints

    received from rural areas and a 48% increase in the number received from semi-

    urban areas.61 This may be the result, at least in part, of numerous outreach

    activities carried out by the Banking Ombudsmen, such as awareness camps

    (particularly in rural areas), the showing of slides in movie theaters and newspaper

    advertisements.62

    The statistics showing a steady annual increase in the number of complaints in 2008-

    2009 might indicate that the authority of the Banking Ombudsmen has a good

    reputation and social approval. In order to handle this growth, the 15 Ombudsmen

    offices in India had to recruit additional staff. The total expenditure of operating the

    offices is fully borne by the RBI. In order to ensure that the Banking Ombudsmen

    Scheme is effective, the RBI understands that more emphasis should be placed on

    an outcome-based approach, where outcomes are quantitatively measured, and a

    regulatory response is formulated accordingly.63

    3. Field Research

    3.1 Methodology - Research Design

    The analytical framework is based on determining if borrower rights are being

    abused by possible significant shortcomings in the contracting and debt recovery

    practices of MFIs. The following five broad questions needed to be answered in order

    to make a determination:

    1) What are the legal requirements governing lending by MFIs, particularly in relation

    to protection of consumers in the contracting, dispute resolution, and debt recovery

    processes?

    2) Are there any gaps in the regulatory framework in relation to international

    obligations or accepted international practice?

    58 Reserve Bank of India, The Banking Ombudsman Scheme 2006, Annual Report 2008-2009, 17. 59 Ibid 6, 8. 60 Ibid 10. 61 Ibid 5. 62 Ibid 21-22. 63 Ibid iii.

  • 26

    3) To what extent are current practices consistent with legal requirements (or good

    practice more generally)?

    4) What areas of inconsistency are most significant?

    5) What factors underlie each major problem?

    Along with these five questions, there were more detailed technical questions which

    had been incorporated into questionnaires for each stakeholder category. This

    research focuses on three groups of stakeholders: MFIs, Clients, Judges and

    Ombudsmen. Unfortunately, of all the Judges and Ombudsmen contacted by the field

    research group, only three Ombudsmen agreed to participate in this survey.

    However, it must be noted that in other jurisdictions, IDLO encountered similar

    problems in involving Judges in research activities linked to sensitive topics such as

    consumer protection, though in India this condition may have been exacerbated by

    the tensions within the microfinance sector.

    Following analysis of Questions 1 and 2, it was possible to construct a set of

    standards for what might be considered good practice. This framework provided

    the basis for analysis of actual practices in Question 3. Question 3 identified a wide

    range of problems, and question 4 allowed an examination of the significance of

    those problems in terms of their level of incidence. This was important in order to

    ensure that subsequent, more in-depth analysis (Question 5) was focused on those

    issues that were likely to yield the most significant benefit.

    Table 1. Research Questions and Methodological Tools

    Research Questions

    Methodological tools

    Regulatory Framework what standards of

    performance are expected?

    What are the legal requirements governing

    lending by MFIs, particularly in relation to

    protection of consumers in the contracting,

    dispute resolution, and debt recovery

    processes?

    Literature Review

    Stakeholder

    Interviews

    Are there any gaps in the regulatory

    framework in relation to international

    obligations or accepted international

    practice?

    Desk analysis

    Stakeholder

    Interviews

    Current Practice what standards of

    performance are being delivered?

    To what extent are current practices

    consistent with legal requirements (or good

    practice more generally)?

    Literature Review

    Stakeholder

    Interviews

    Borrower Survey

    What areas of inconsistency are most

    significant?

    Literature Review

    Stakeholder

    Interviews

  • 27

    Research Questions

    Methodological tools

    What factors underlie each major problem? Literature Review

    Stakeholder

    Interviews

    Structured interviews were used with clients to confirm or provide more insight on

    the factual information collected from other sources. In these interviews, a pre-

    determined list of questions was asked, with the interviewee not asked to elaborate

    beyond his or her answers to those questions. Semi-structured interviews were used,

    using open-ended questions, with MFI employees. In these interviews, a topic or

    issue was introduced, and a conversation ensued, facilitated by the interviewer.

    3.2 Microfinance Institutions

    Five Indian MFIs were selected, taking into account two variables: (1) legal status

    (NBFC, Section 25 Company, society, etc.) and (2) market share. The goal was to

    select a sample of MFIs with large market share representing each of the major

    types of legal entity.

    For each MFI, at least two employees were interviewed: an agent/credit officer (at

    least one of whom processes a borrowers individual credit request) and a manager

    (or legal counsel, with knowledge of the MFIs overall portfolio and credit request

    process).

    Table 2. Sample of MFIs

    Financial Institutions Gross Loan Portfolio (in

    USD)

    Number of Active

    Borrowers

    Regulated64

    Bandhan (NBFC) $332,462,204 2,301,433

    Ujjivan (NBFC) $82,447,140 566,929

    Largely Unregulated65

    BISWA (Society) $58,971,572 305,679

    Cashpor MC (Section 25

    Company) $59,461,459 417,039

    Humana People to People

    India ( 25 Co.) N/A N/A

    Source: MIX Market, 2009

    Based on interviews conducted using the methodology described above, we found

    that group loans targeting poor women, per the Grameen Bank model of lending,

    64 Financial regulation and supervision by the RBI. 65 Registration required with the Registrar of Societies and the Registrar of Companies, respectively, but not subject to financial regulation and supervision by the RBI.

  • 28

    were the primary microfinance product offered by the MFIs we interviewed. Some

    MFIs had piloted individual loans, including home loans and education loans. Other

    innovative loan products included loans for products such as mobile phones, water

    purifiers and solar lamps.

    3.2.1. Assessment of Customers Ability to Repay

    Triangulation is the most common method used by all MFIs to assess customers

    ability to repay their loans. The method involves obtaining information about the

    borrower from family members, neighbors, and group members. The information is

    also discussed at group meetings (Group Recognition Tests (GRT)) to foster truthful

    answers.

    In some areas, particularly where competition is high, like in the city of Kolkata, MFIs

    are beginning to informally share information about their borrowers to avoid multiple

    borrowings and to prevent over-lending. Since MFIs do not secure their clients'

    approval to do this, these informal practices do not conform to Indias model deposit

    policy that guides banking secrecy, and may pose some serious privacy issues. Some

    MFIs mentioned an initiative, led by MFIN, to formalize the information-sharing

    procedures. The goal is that a formal credit bureau will eventually be established to

    serve MFIs.

    3.2.2. Use of Client Information

    Even without formal credit information sharing, sharing of client information has

    already taken place. A significant difference between how the use of client

    information was dealt with by regulated MFIs, on the one hand, and by unregulated

    MFIs, on the other, was evident. NBFCs chose to include provisions regarding

    information-sharing in the loan contract and receive the clients signature in

    acceptance. On the other hand, unregulated MFIs do not discuss information-sharing

    with the client, because information is not being shared formally.

    3.2.3. Information Provided to Consumers

    Information is provided to consumers at several different times, and in several

    different ways. Information is provided orally at Continuous Group Trainings (CGT)

    and in writing in the CGT brochure. Clients are encouraged to take the brochures,

    analyze them while at home, discuss the terms with family, and return with any

    questions or concerns. The loan specifics are discussed once more at the GRT, and

    again at the time of disbursement. Each time the terms are discussed, the loan

    officer or branch manager is trained to gauge or test the clients understanding and

    ask for the clients agreement. In addition to loan terms, the consequences of

    missing a payment are explained to the borrowers in the CGT, GRT and at the time

    of disbursement. Lastly, key information, such as the interest rate, is written in the

    loan application filled out by clients and also in the client's passbook or loan card.

    3.2.4. Debt Collection Practices

    There is a difference between the debt collection practices of regulated MFIs (in this

    case, NBFCs) and unregulated MFIs. The NBFCs we interviewed were able to

    articulate a clear policy about how default is categorized and action is taken and

    evaluated based on the type of default. For the NBFC, the use of force or coercion

    was not acceptable. On the other hand, the procedure of one of the unregulated

  • 29

    MFIs interviewed was more one-size-fits-all, and action taken by the borrowing

    group to ensure repayment was seen by the MFI as acceptable because it was not

    carried out by the MFI.

    To explain more fully, the NBFCs we interviewed categorize a default as either

    intentional, unintentional (short and long term), technical or mass default. If the

    default is intentional or unintentional and short term, a loan officer or branch

    manager will visit the client and try to persuade the client to pay while also

    contacting other group members to convince them to pay on behalf of the defaulting

    member. It was clear that using force or coercion would be unacceptable. If the

    default is unintentional but long term, the client is visited by members of the NBFCs

    credit and vigilance team and the debt is rescheduled or the borrower is given a

    repayment holiday. If the NBFC experiences mass defaults, the head office and

    regional representatives take steps to contact the leaders of the instigating group

    and encourage them to change the defaulting behavior. Technical defaults are

    accounting and information system errors, which are corrected by the NBFC.

    Contrast this with the case of one unregulated MFI. The MFIs branch manager

    indicated that the group had to pay on behalf of the defaulting member before

    leaving the group meeting. MFI staff will then visit the defaulting member to

    determine why he or she defaulted. However, in a situation where the client has

    absconded, the group will put pressure on the borrowers family members to repay

    the loan. In extreme cases, if the group is unsuccessful in attempts to convince the

    borrower or her66 family to repay the loan, the group will seize business or household

    assets and sell them to recover the amount. The MFI manager did not seem to view

    this as a problem, because the MFI is facilitating group responsibility and the

    recovery activity is carried on by the group.

    MFIs do not normally resort to legal enforcement because the process is too lengthy

    and too costly. At least one MFI, however, has initiated legal proceedings in rare

    instances (only individual borrowers, typically with high balances) to demonstrate its

    seriousness. The full costs of litigation could not yet be assessed, because the policy

    was enacted recently. The MFI recognized that it can take several years to obtain a

    decision.

    3.2.5. Redress Mechanisms for Consumer Complaints

    If a client has a complaint, he or she is invited to speak with a manager or to call a

    dedicated helpline. Some branches even have dedicated customer service staff that

    borrowers are encouraged to speak to. The helpline numbers are displayed in

    branches and included in the loan cards given to borrowers. The phone numbers are

    also in the information discussed and/or distributed at the CGT and GRT. Group

    leaders are encouraged to use the helpline and to remind other group members to

    use it as well.

    The regulated MFIs regularly audit the redress mechanisms to ensure that they are

    working effectively. Customer service issues are raised at meetings of the board of

    directors. All MFIs interviewed noted that loan officers have started receiving soft

    training on how to treat customers and handle customer complaints. If an employee

    misbehaves, the MFIs have clear policies to provide a written warning, followed by

    disciplinary notice, and finally dismissal.

    66 As stated in section 2.3, all clients in our sample are women.

  • 30

    3.3 Clients

    For each MFI, 10 clients were interviewed. Overall, 86% of the clients were non-

    defaulting borrowers. The sample size was determined by a number of factors

    including the extent to which there were distinct subpopulations within the total

    target population. In particular, the sample was constructed in such a way as to

    include all the key sub-populations across the five MFIs, in similar proportions as

    they exist in the total population. As such, the survey has been a non-random or

    purposive survey.

    Key sub-populations were determined with these categories and given appropriate

    representation:

    Different age groups;

    Different geographic areas, particularly where those areas coincide with socio-

    economic differences; and

    Defaulting and non-defaulting borrowers.

    A detailed methodology for administering the survey was developed by M-CRIL,

    which tested the survey with a small group of respondents. After some changes to

    tailor the methodology to the Indian context, the testing process confirmed that the

    questions were clear, and that the correct range of possible responses had been

    included for each question.

    3.3.1. Client Selection of MFIs

    More than a third of the clients interviewed admitted that they did not know the type

    of institution from which they borrowed; however, many of the clients who did

    attempt to identify the type of institution were wrong in their classification. For

    example, 40% of the clients interviewed had borrowed from an NBFC, but none of

    the clients were able to identify that they had in fact borrowed from an NBFC. More

    than one-third of the clients answered that they borrowed from a bank, but banks

    were not even part of the sample. In an industry where an institutions reputation is

    important to potential clients, a regulators stamp of approval can be a symbol of

    that reputation and may help to reinforce norms and best practices. However, clients

    have to know what type of institution they are borrowing from to determine whether

    or not it is regulated. If not, then the reputational benefits of regulation may be lost.

    Consumers often do not have a choice of financial institutions to borrow from.

    Whether the lack of choice is real or only perceived, the result is the same: the

    consumer believes that other credit alternatives do not exist, so she may be more

    likely to accept abuses.67

    67 Whether or not an MFI client chooses to seek redress through the consumer or civil courts is a different problem. That problem is rooted in the level of awareness of legal rights, ease of access to courts, and costs of adjudication.

  • 31

    Figure 1. Did you have the choice between several financial institutions?

    Where consumers did had a choice, the reason most often cited for choosing the

    financial institution was a lower interest rate or a shorter repayment schedule.

    Among the clients who did have a choice, the vast majority did not have loans with

    another financial institution.

    Figure 2. Did you have loans at other financial institutions?

    Consumers first learned about the MFI from which they borrowed exclusively from

    friends or MFI salespersons, with about 85% of defaulting borrowers learning about

    the MFI from salespersons. Overall, in our sample, a borrower was less than twice as

    likely to have first learned of the MFI from a salesperson.

    Figure 3. How did you first hear about the MFIs services?

    0% 20% 40% 60% 80%

    Defaulting borrowers No

    Yes

    0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

    Yes

    No Non-defaulting

    Defaulting

    0% 10% 20% 30% 40% 50% 60%

    Advertisement

    Friends

    Salesperson

    Other

    Non-defaulting

    Defaulting

  • 32

    Surprisingly, all of the consumers interviewed indicated that all of the information

    provided to them about the MFI, whether through friends or salespersons, was

    completely accurate.

    3.3.2. Requirements for Receiving Credit

    Every borrower in our sample had a loan secured by a personal guarantee. Often,

    the personal guarantee was used in the group lending mechanism, whereby each

    member of a group guaranteed the loans of all members of the group.

    In order to obtain their loans, all of the borrowers needed to provide identification,

    and a few also needed to provide proof of address. Also, the borrowers were required

    to attend meetings prior to loan disbursal. This requirement ranged from as few as

    two meetings to as many as six months of group meetings coupled with savings.

    Borrowers at both ends of the spectrum had defaulted. Most borrowers indicated that

    they had received their funds within one to three weeks after completing their loan

    application.

    Figure 4. Time from Loan Application to Disbursal of Funds or Denial

    3.3.3. Information on Contract Terms and Conditions

    Every client interviewed indicated that the loan agreement was clearly explained to

    them, and about 40% indicated that they had been given a copy of the agreement in

    writing. A large majority, nearly 86%, of defaulting borrowers indicated that they

    had received a written copy of the loan agreement.

    Figure 5. Were you given a copy of the loan agreement?

    0% 10% 20% 30% 40%

    Less than a week

    Between 1 and 2 weeks

    Between 2 and 3 weeks

    More than 3 weeks

    Non Defaulting

    Defaulting

    0% 15% 30% 45% 60% 75% 90%

    Defaulting

    Non-defaulting

    Yes

    No

  • 33

    Of those clients who had received a copy of the loan agreement, all of them indicated

    that they still retained a copy of the agreement.

    All clients said that they had received information about key terms such as interest

    rate, fees and repayment terms. Invariably, however, the clients did not receive any

    information about loan modification or the protection and/or use of customer

    information by the financial institution. Importantly, the clients of the regulated

    NBFCs in the sample had also received information about events of default,

    consequences of late or missed payments, options for recourse if unsatisfied with the

    MFI, and other general information about borrowers rights. Some unregulated

    societies and not-for-profit companies provided this sort of information to clients, but

    others did not provide it.

    Table 3. Communication of Terms and Conditions

    The borrowers had extremely poor knowledge and understanding of the annual

    percentage rate (APR). First, when asked if they knew what APR their loan carried,

    the borrowers responded that they did not know and proceeded to explain that they

    knew either the monthly interest rate or the annual flat rate. Only one borrower was

    able to unequivocally state that she borrowed at an APR of 26 percent. Moreover, all

    of the borrowers interviewed stated that they were unable to explain what APR

    means.

    3.3.4. Consequences of Late Payment

    Nearly all of the defaulting borrowers in our sample cited dissolution of the borrowing

    group as the consequence of missed or late payments. Only one interviewee,

    however, stated that the consequence would be an increase in the interest rate

    changed on the loan. This suggests that the group lending mechanism is the primary

    incentive for repayment in the Indian microfinance sector.

    What information, if any, was conveyed

    to you by the MFI regarding:

    Defaulting

    Non-defaulting

    Yes No Yes No

    Interest rate 100% 0% 100% 0%

    Fees 100% 0% 100% 0%

    Repayment terms 100% 0% 100% 0%

    Consequences/penalties for late or

    missed payments 85.71% 14.29% 96.88% 3.13%

    Events of default and consequences 100% 0% 100% 0%

    Procedure for modifications to the

    agreement and the possibility of unilateral

    changes by the MFI

    0% 100% 0% 100%

    Options for recourse if unsatisfied with the

    MFI 85.71% 14.29% 75% 25%

    Protection/use of customer information 0% 100% 0% 100%

  • 34

    All of the defaulting borrowers indicated that the group guarantee was an avenue of

    recourse when payments were late or missed. However, only one of the defaulting

    borrowers actually resorted to using the group guarantee. All the rest of the

    defaulting borrowers suggested that they couldnt pay for others and/or others

    wouldnt pay for them. As a result, we observed that where a borrowing group is

    made up of individuals who are often economically related, one members inability to

    repay will often mean that other members are also unable to repay.

    In each instance of default, the MFI or third party collector contacted the borrower

    by personal visits. In these contacts, the MFI or agent communicated that if the

    borrower failed to pay, further loans would cease. The MFIs did not make any

    attempt to restructure the loan. Two of the defaulting borrowers, however, did

    request restructuring only to have their request denied by the MFI.

    Figure 6. In case of complaints, from whom could you get assistance?

    In instances where the borrowers had complaints, nearly every borrower turned to

    the MFI management for assistance. Only about 16% of borrowers also took

    advantage of a helpline. No borrower in our study was involved in formal

    adjudication related to her loan. This data reveals that the MFIs are in a prime

    position to deal with customer complaints and disputes, and the MFI is most often

    the only source of help that borrowers turn to.

    3.4 Ombudsmen

    After we attempted to contact all 15 Banking Ombudsmen in India, three of them

    eventually responded. The questions were designed to elicit answers that would draw

    on the Ombudsmens experience, helping us to develop a deeper understanding of

    the Banking Ombudsman Scheme.

    3.4.1. Disputes

    Indian Banking Ombudsmen often hear disputes stemming from credit cards and

    loan products and services. The most common cause for grievances is a lack of

    transparency regarding the contractual terms of the product or service. The lack of

    transparency leads to customer misunderstanding and disputes. With regards to

    0% 15% 30% 45% 60% 75% 90%

    A financial ombudsman

    MFI management

    MFI

    Private legal counsel

    Legal aid

    Customer service helpine

    Defaulting

    Non-defaulting

  • 35

    loans, the grievances are often due to changing interest rates or other terms, as well

    as foreclosure and alleged misbehavior of the recovery agent. While the Ombudsmen

    hear disputes related to the misuse of personal information or misleading promotions

    or advertising, it is unusual for such disputes to come before the Ombudsmen.

    Disputes before the Ombudsmen seem to be lodged against the different types of

    institutions in proportion to the institutions market share. Therefore, with public

    banks having the largest market presence, most complaints were against public

    banks. However, at least one Ombudsman answered that most complaints were

    against private banks.

    3.4.2. Procedures

    Resolving a complaint may take as little as one month, or as long as three months if

    the complaint filed is unclear. In cases where it takes longer to resolve a complaint,

    it is usually due to the banks needing to investigate the complaints against them and

    gather and submit documentary evidence. Also, where it is necessary to provide the

    complainant with an in-person, hearing there needs to be reasonable notice, which is

    usually considered to be 10 days. If the complainant does not accept the banks

    proposed resolution, then further conciliation efforts are needed which results in

    delay.

    Attorneys are not allowed to file complaints on behalf of consumers before the

    Banking Ombudsmen, according to Article 9 of the Banking Ombudsman Scheme.

    According to the Ombudsmen interviewed, this is to prevent the process from

    becoming complex and costly. The Banking Ombudsman Scheme is intended to

    provide consumers with a cost-free and hassle-free mechanism for the redress of

    grievances related to service deficiencies. Proceedings before the Banking

    Ombudsmen are summary in nature and do not involve complicated legal processes.

    Also, because most complaints are adjudicated on the basis of documents enclosed

    with the complaint and the banks response, an attorney is considered an

    unnecessary cost. It is possible, however, that some of the complainants get their

    complaints drafted by an attorney, but they submit the complaint personally or

    through a family member who is not an attorney. Complainants usually represent

    themselves in mediation before the Banking Ombudsman, although they can also be

    represented by friends or relatives. The banks are represented by their customer

    service executive (Nodal Officer) and/or other managers or officers who are familiar

    with the complainants case.

    Instances of parties having difficulty producing documentation or evidence are

    relatively rare, though they occur from time to time. Banks are required to have a

    record management policy and, in majority of the cases, all material records

    regarding the disputed transactions are produced by the banks. However, difficulties

    do arise where a complainant claims to have made service requests by telephone or

    in writing for which he or she is unable to produce evidence and such claims are

    denied by the bank.

    3.4.3. Awards and Enforcement

    It is possible to issue an award against a party in absentia during a mediation

    procedure. The conciliation process in the Banking Ombudsman Scheme is an

    opportunity given to both parties to resolve their dispute by mutual agreement.

    According to one Ombudsman interviewed, banks usually attend the conciliation

  • 36

    proceedings. Article 10(1) of the Banking Ombudsman Scheme empowers the

    Banking Ombudsman to request information from the banks. If a bank fails to

    comply with the request for information without sufficient cause, the Banking

    Ombudsman may infer that the information, if provided, would be unfavorable to the

    bank. Whether or not either party attends the conciliation proceedings, the Banking

    Ombudsman adjudicates the complaint taking into account the evidence and other

    material on record.

    While proceedings before the Banking Ombudsmen are summary in nature, and the

    Ombudsmen are not bound by rules of evidence, the decisions of the Banking

    Ombudsmen are based on the evidence placed before them, conform to the

    principles of banking law and practice, and are consistent with public policy.

    An Ombudsmans decision is enforced through a name-and-shame mechanism.

    Under the regulatory framework, banks are required to report all awards by a

    Banking Ombudsman to the Customer Services Committee of their Board of

    Directors. Banks are also required to disclose the number of unimplemented awards

    in their annual report as part of the mandatory disclosures. Therefore, banks have an

    incentive to implement Ombudsmen decisions to avoid public disclosure of

    unimplemented awards.

    3.4.4. Content and Clarity of Financial Contracts

    Loan contracts are drafted by the banks legal specialists; consequently, all

    provisions favor the bank. For example, one Ombudsman noted that some loan

    contracts call for a floating interest rates, but dont mention how the rate will be

    calculated.

    To improve the transparency of contracts, the Reserve Bank of India has issued

    guidelines requiring banks to highlight the most important terms and conditions

    (MITC), particularly relating to interest and fees and to obtain the customer's

    signature in acknowledgment. One Ombudsman suggested that a sample contract be

    posted on bank websites so that customers can read and understand it at his or her

    convenience prior to signing the contract.

    3.4.5. Other Recourse and Applicability to Microfinance

    The valid grounds for complaints are enumerated in Article 8 of the Banking

    Ombudsman Scheme. Under the Scheme, the Banking Ombudsmen have no

    authority to reduce a debt or absolve a debtor. In addition to the Banking

    Ombudsmen, customers who have complaints can file a suit in the Consumer Court

    or Civil Court.

    Customers of NGO-MFIs have recourse to the full range of legal remedies under the

    CPA and other relevant statutes, but they cannot bring their complaints before the

    Banking Ombudsmen. NGO-MFIs in India are not under a robust regulatory and

    supervisory framework, as banks are. The Ombudsmen interviewed agreed that such

    regulation and supervision is necessary before a redress mechanism similar to the

    Banking Ombudsman Scheme could be put in place for NGO-MFIs. However, there

    have been Ombudsmen schemes established elsewhere for unregulated financial

    services sectors that have worked well.

  • 37

    4. Recommendations

    It appears evident that the technologically challenged and the illiterate poor find it

    difficult to access consumer protection authorities. Consequently, complaint and

    grievance procedures should be made simpler and more rapid by not requiring

    customers to file complaints in writing, thus making the procedures more accessible

    to illiterate customers and those who reside in remote rural areas. Redress

    mechanisms need to be more effectively advertised to raise consumer awareness on

    options available to them. Moreover, when grievance redress and complaint handling

    are outsourced by the MFIs, consumer protection and financial literacy campaigns

    are particularly needed.

    To improve the contracts transparency, the RBI has issued guidelines requiring

    banks to highlight the Most Important Terms and Conditions (MITC), particularly

    relating to interest and fees and to obtain the customers signature in

    acknowledgment. IDLOs research has indicated the need for a further step: contract

    specimen must be accompanied with standardized information conveyed in plain

    language, in a way easily comprehended by poor people, some of whom struggle

    with illiteracy. For instance, the MFI should provide the client with a clearer payment

    schedule, translating interest rates into payments per month, clearly differentiating

    between principal and interests. Also, placing this kind of information and contract

    specimen on the MFIs websites would allow customers to read and understand them

    at their convenience prior to signing the contract. This option, obviously, should be

    available to low-income clients with a minimal degree of education and information

    technology and internet knowledge. Perhaps for illiterate consumers, lenders should

    be required to convey the standardized information orally to them.

    Estimates from the Banking Ombudsmen indicate that the cost of dealing with

    appellate complaints is Rs 2,600.68 The cost is now fully borne by the RBI, but

    financial entities should be asked to bear part of this burden, thereby transferring

    the responsibility for customer protection from the regulator to the banks. The

    initiatives taken for voluntary adoption of codes of conduct and fair practices through

    industry associations and the BCSBI are a good start. Financial institutions, however,

    should consider consumer protection as an investment, boosted by consumer

    awareness campaigns led by the government and RBI.

    Although customers of NGO-MFIs have recourse to the full range of legal remedies

    under the CPA and other relevant statutes, they cannot bring their complaints before

    the Banking Ombudsmen. Considering that NGO-MFIs in India are not under a robust

    regulatory and supervisory framework as banks are, this study fully endorses the

    recommendation of the interviewed Ombudsmen that such regulation and

    supervision is necessary before a redress mechanism similar to the Banking

    Ombudsman Scheme could be put in place for NGO-MFIs. However, even before

    regulation and supervision is implemented, the NGO-MFIs would benefit from

    adopting a Banking Ombudsman Scheme.

    In general, to establish a comprehensive consumer protection regulatory framework

    for financial services, India may also consider the following recommendations:

    68 Approximately, US$59.

  • 38

    Prohibiting reckless lending (similar to the provisions in South Africas

    National Credit Act (NCA)). The South African Act protects consumers from

    reckless lending, and provides them with an understandable credit agreement

    in plain language and several other consumer protections.

    Requiring financial services firms to explain clearly to potential borrowers the

    key features (including any fees, commissions or other charges) of products

    and services.

    Ensuring clear, fair and full disclosure of interest rates and charges (e.g.,

    APRs or total cost of credit).

    Ensuring that debt recovery expenses charged to the consumer, if any, are

    reasonable.

    Requiring that any advice given by a financial services entity to a consumer

    should be suitable for the consumer and take into account his or her

    circumstances.

    Prohibiting conditional sales. A conditional sale is an arrangement in which a

    buyer takes possession of an item, but the title remains with the seller until

    some condition is met, such as payment of the full purchase price.

    Instituting a cooling off period for certain loans, e.g., loans above a certain

    value and for a duration greater than a specified period of time.

    Requiring that financial firms periodically issue financial statements to

    consumers at stated intervals.

    Requiring that notifications be sent to consumers when an institution makes

    changes in the terms and conditions of financial products.

    Requiring proper training, professional standards and supervision of relevant

    staff of financial entities or their agents.

    Requiring that financial entities treat consumers fairly, and enacting

    prohibitions on unfair, deceptive or aggressive practices.

  • 39

    Annex I- Regulatory Framework for Relevant Subjects

    Banking:

    Primary Regulator:

    1) RBI

    2) NABARD, supervises RRBs

    Primary Laws:

    1) Reserve Bank of India Act 1934

    2) Banking Regulation Act 1949

    3) National Bank for Agriculture and Rural Development Act 1981

    4) Regional Rural Banks Act 1976

    5) Banking Companies (Acquisition and Transfer of Undertaking) Act 1969

    6) Recovery of Debts Due to Banks and Financial Institutions Act 1993

    7) Securitization and Reconstruction of Financial Assets and Enforcement of

    Security Interest Act 2002

    Microfinance: Microfinance in India is provided by commercial banks, RRBs, SHGs

    (with special linkage programs to banks), cooperative societies, and other MFIs. MFIs

    generally take a variety of forms, including NGOs (registered as societies, trusts or

    Section 25 companies) and NBFCs. Each type of institution is subject to different

    oversight and supervision.

    Most MFIs register as NGOs, rather than NBFCs, and as a result, they fall outside of

    the regulatory framework. Hundreds of MFIs, however, have joined network

    organizations such as Sa-Dhan and MFIN. MFIN has created a Code of Conduct in

    order to prevent over-lending to individual borrowers, while Sa-Dhan has developed

    a Code of Conduct as well. Leading NBFC MFIs have also joined forces to form Alpha

    Micro Finance Consultants P Ltd, in order to establish a credit bureau that will

    provide related services to MFIs in India.

    Banking and Microfinance Regulations:

    1) Master Circular on Micro-Credit (enacted in 2008)

    2) Master Circular on Lending to Micro, Small and Medium Enterprises (MSME)

    Sector (enacted in 2008)

    3) Master Circular on Lending to the Priority Sector (introduced in 2009)

    NGOs and Non-Banking Financial Companies (NBFCs)

    1) Indian Trusts Act No. 2 of 1882

    2) Charitable and Religious Trusts Act 1920

    3) Societies Registration Act No. 21 of 1860

    4) Companies Act, 1956, Section 25

    5) Master Circular on Fair Practices for NBFCs (adopted in 2009)

    6) Each state in India typically has a version of a societies act

    Payment Systems:

    Primary Regulator:

    1) RBI

    2) The National Payment Corporation of India (NPCI), under the authority of the

    RBI, is responsible for building and consolidating a nationwide payment

    system in India.69

    69 National Payment Corporation of India (NPCI) http://www.npci.org.in/home.aspx.

    http://www.npci.org.in/home.aspx

  • 40

    Primary Laws:

    1) Negotiable Instruments Act 1881

    2) Payment and Settlement Systems Act 2007

    Telecommunication:

    Primary Regulator:

    1) The Department of Telecommunications

    2) The Telecom Regulatory Authority of India (TRAI) is responsible for oversight

    of the telecom industry and enforcement of telecom laws.

    Primary Laws:

    1) The Indian Telegraph Act 1885

    2) The Indian Wireless Telegraphy Act 1933

    3) The Information Technology Act 2001

    4) Mobile Banking Transactions in India Operative Guidelines (introduced in

    2009)

    Financial Consumer Protection: Consumer protection in India is regulated by both

    statutory regulation and monitored by voluntary membership bodies. Key players in

    consumer protection include the RBI, the BCSBI and the Indian Banking Association.

    Pursuant to RBI circulars, banks have established internal customer service

    mechanisms to receive and address complaints in a fair and efficient manner. Where,

    in the opinion of the customer, complaints have not been fully or adequately

    resolved, the RBI has set up local Banking Ombudsmen, who act as mediators and

    arbiters of customers disputes. Also for the resolution of customer disputes, the

    Consumer Protection Act 1986 established consumer courts that do not require

    consumers to have legal representation in order to press claims, as well requiring

    banks to establish internal customer service mechanisms.

    Primary Regulators:

    1) RBI

    2) Central Consumer Protection Council and the State and District Consumer

    Protection Councils

    3) BCSBI

    Primary Laws:

    1) Consumer Protection Act No. 68 of 1986

    2) RBI Circular on Grievance Redressal Mechanism in Banks (enacted in 2008)

    3) RBI Circular on the Use of Business Facilitators and Business Correspondents

    (introduced in 2006)

    4) Competition Act 2002

    5) Prize Chits and Money Circulation Schemes (Banning) Act 1978

    6) The Chit Funds Act 1982

    The following are applicable to BCSBI member banks:

    1) Code of Banks Commitments to Customers (adopted in 2009)

    2) Banking Code Rules

  • 41

    Interest:

    Primary Regulator:

    1) RBI

    Primary Laws:

    1) Indian Moneylenders Act 1918

    2) Banking Regulation Act 1949

    3) Usurious Loans Act 1918

    4) Master Circular on Interest Rates on Advances (enacted in 2007)

    E-money: India does not yet have laws governing e-money. Retail banking outlets,

    however, have already started introducing the use of e-money. The RBI oversees the

    use of e-money.

    Competition:

    Primary Regulator:

    1) The Competition Commission

    Primary Laws:

    1) Competition Act 2002

    2) Competition Commission Act 2005

    3) Essential Commodities Act 1955

    Consumer Business Information:

    Primary Regulator:

    1) RBI

    Primary Laws:

    1) The Prevention of Money Laundering Act (PMLA) 2002

    2) Combating Financing of Terrorism under Unlawful Activities (CFT Prevention)

    Act 1967

    3) Banking Secrecy Act

    Deposit Insurance:

    Primary Regulator:

    1) DICGC

    Primary Laws:

    1) Deposit Insurance Act 1961

    2) Deposit Insurance and Credit Guarantee Corporation (DICGC) Act 1961

    Guarantee Funds:

    Primary Regulator:

    1) SIDBI

    2) The Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE)

    Primary Laws:

    1) Credit Guarantee Fund Scheme for Micro and Small Enterprises

  • 42

    Anti-Money Laundering:

    Primary Regulator:

    1) RBI

    2) The Financial Intelligence Unit, reporting to the Economic Intelligence Council,

    which is headed by the Finance Minister

    Primary Laws:

    1) The Prevention of Money Laundering Act (PMLA) 2002

    2) Combating Financing of Terrorism under Unlawful Activities (CFT Prevention)

    Act 1967

    3) Master Circular on Know Your Customer Norms/Anti-Money Laundering

    Standards/Combating of Financing of Terrorism Obligations of Banks Under

    PMLA of 2002 (introduced in 2009)

  • 43

    Annex II- Form of Complaint (to be lodged) with the Banking Ombudsman

    (To be filled up by the Complainant)

    To:

    The Banking Ombudsman

    Place of BOs office

    Dear Sir,

    Sub: Complaint against (Name of the banks branch) of

    (Name of the Bank)

    Details of the complaint are as under:

    1. Name of the Complainant

    2. Full Address of the Complainant

    Pin Code

    Phone No/ Fax No.

    Email

    3. Complaint against (Name and full address of the branch/bank)

    Pin Code

    Phone No. / Fax No.

    4. Particulars of Bank or Credit card Account (If any)

    5. (a) Date of representation already made by the complainant to the bank

    (Please enclose a copy of the representation)

    (b) Whether any reminder was sent by the complainant? YES/NO

    (Please enclose a copy of the reminder)

    6. Subject matter of the complaint (Please refer to Clause 8 of the Scheme)

    7. Details of the complaint:

    (If space is not sufficient, please enclose separate sheet)

    8. Whether any reply (Within a period of one month after the bank concerned

    received the representation) has been received from the bank? Yes/ No

    (If yes, please enclose a copy of the reply.)

  • 44

    9. Nature of Relief sought from the Banking Ombudsman

    (Please enclose a copy of documentary proof, if any, in support of your claim.)

    10. Nature and extent of monetary loss, if any, claimed by the complainant by way

    of compensation (please refer to clauses 12 (5) & 12 (6) of the Scheme)

    Rs.

    11. List of documents enclosed:

    (Please enclose a copy of all the documents.)

    12. Declaration:

    (i) I/We, the complainant/s herein declare that:

    a) The information furnished herein above is true and correct; and

    b) I/We have not concealed or misrepresented any fact stated in the above

    columns and in the documents submitted herewith.

    (ii) The complaint is filed before expiry of period of one year reckoned in

    accordance with the provisions of Clause 9(3)(a) and (b) of the Scheme.

    (iii) The subject matter of the present complaint has never been brought before

    the Office of the Banking Ombudsman by me/ us or by any of the parties

    concerned with the subject matter to the best of my/ our knowledge.

    (iv) The subject matter of the present complaint has not been decided

    by/pending with any forum/court/arbitrator.

    (v) I/We authorise the bank to disclose any such information/ documents

    furnished by us to the Banking Ombudsman and disclosure whereof in the

    opinion of the Banking Ombudsman is necessary and is required for redressal

    of our complaint.

    (vi) I/We have noted the contents of the Banking Ombudsman Scheme, 2006.

    Yours faithfully,

    (Signature of Complainant)

    Nomination (If the complainant wants to nominate his representative to appear

    and make submissions on his behalf before the Banking Ombudsman or to the Office

    of the Banking Ombudsman, the following declaration should be submitted.)

    I/We the above named complainant/s hereby nominate

    Shri/Smt who is not an Advocate and whose

    address is

    as my/our REPRESENTATIVE in all proceedings of this complaint and confirm that

    any statement, acceptance or rejection made by him/her shall be binding on me/us.

    He/She has signed below in my presence.

    ACCEPTED

    (Signature of Representative)

    (Signature of Complainant)

    Note: If submitted online, the complaint need not be signed.

  • 45

    References

    Banking Regulation Act 1949 (India).

    Central Intelligence Agency (CIA), The

    World Factbook: India

    https://www.cia.gov/library/publicatio

    ns/the-world-factbook/geos/in.html

    CGAP (Consultative Group to Assist the

    Poor), Consumer Protection Policy

    Diagnostic Report: India 2010.

    Clinton Global Initiative, Annual

    Meeting Special Session: Profiting from

    the Poor? A Discussion on Microfinance

    IPOs (2010)

    http://www.clintonglobalinitiative.org/

    ourmeetings/2010/meeting_annual_m

    ultimedia_player.asp?id=83&Section=

    OurMeetings&PageTitle=Multimedia

    summarized at

    http://www.clintonglobalinitiative.org/

    ourmeetings/2010/pdf/session_summa

    ries/Tuesday,%20Microfinance%20SS

    %20Summary.pdf

    The Constitution of India.

    Credit Information Bureau India

    Limited (CIBIL), FAQs,

    http://cibil.com/faqs.htm

    Indian Banks Association,

    http://www.iba.org.in/model_depositp

    olicy.asp

    Indian Contract Act 1872 (India).

    Indian Registration Act 1908 (India).

    A. Kazmin, Microfinance warns of

    collapse over credit freeze, Financial

    Times, 26 October 2010.

    E. Kinetz, Indian microfinance warns

    of crisis after suicides, The Associated

    Press, 28 October 2010.

    E. Kinetz, SKS Launches India's First

    Microfinance IPO, The Associated

    Press, 28 July 2010.

    P. Krar and R. Kumar, RBI puts

    microfinance players on notice,

    Economic Times, 16 October 2010.

    G. Mathew, We are okay with new

    microfinance regulator: RBI, Indian

    Express, 1 November 2010.

    Negotiable Instruments Act 1881

    (India)

    Ministry of Finance, Government of

    India, Economic Survey 2001-2002.

    Reserve Bank of India, The Banking

    Ombudsman Scheme 2006.

    Reserve Bank of India, The Banking

    Ombudsman Scheme 2006, Annual

    Report 2008-2009.

    Reserve Bank of India, Circular on

    Financial Inclusion by Extension of

    Banking Services - Use of Business

    Correspondents 2009.

    Reserve Bank of India, Circular on

    Financial Inclusion by Extension of

    Banking Services - Use of Business

    Correspondents (amendment) 2010.

    Reserve Bank of India, FAQs

    http://www.rbi.org.in/scripts/FAQDispl

    ay.aspx

    Reserve Bank of India, Guidelines on

    Fair Practices Code for Lenders, 6

    March 2007

    Reserve Bank of India, Master Circular

    - Fair Practices Code 2009.

    Reserve Bank of India, Non-Bank

    Financial Companies in India (2001).

    Reserve Bank of India, Report of the

    Task Force to Study the Cooperative

    Credit System and Suggest Measures

    for its Strengthening (2000).

    https://www.cia.gov/library/publications/the-world-factbook/geos/in.htmlhttps://www.cia.gov/library/publications/the-world-factbook/geos/in.htmlhttp://www.clintonglobalinitiative.org/ourmeetings/2010/meeting_annual_multimedia_player.asp?id=83&Section=OurMeetings&PageTitle=Multimediahttp://www.clintonglobalinitiative.org/ourmeetings/2010/meeting_annual_multimedia_player.asp?id=83&Section=OurMeetings&PageTitle=Multimediahttp://www.clintonglobalinitiative.org/ourmeetings/2010/meeting_annual_multimedia_player.asp?id=83&Section=OurMeetings&PageTitle=Multimediahttp://www.clintonglobalinitiative.org/ourmeetings/2010/meeting_annual_multimedia_player.asp?id=83&Section=OurMeetings&PageTitle=Multimediahttp://www.clintonglobalinitiative.org/ourmeetings/2010/pdf/session_summaries/Tuesday,%20Microfinance%20SS%20Summary.pdfhttp://www.clintonglobalinitiative.org/ourmeetings/2010/pdf/session_summaries/Tuesday,%20Microfinance%20SS%20Summary.pdfhttp://www.clintonglobalinitiative.org/ourmeetings/2010/pdf/session_summaries/Tuesday,%20Microfinance%20SS%20Summary.pdfhttp://www.clintonglobalinitiative.org/ourmeetings/2010/pdf/session_summaries/Tuesday,%20Microfinance%20SS%20Summary.pdfhttp://cibil.com/faqs.htmhttp://www.iba.org.in/model_depositpolicy.asphttp://www.iba.org.in/model_depositpolicy.asphttp://www.rbi.org.in/scripts/FAQDisplay.aspxhttp://www.rbi.org.in/scripts/FAQDisplay.aspx

  • 46

    A. Roy and S. Shankaran, RBI permits

    corporations to work as rural agents of

    banks, Mint, 29 September 2010, 1.

    Sa-Dhan, Existing Legal and

    Regulatory Framework for the

    Microfinance Institutions in India:

    Challenges and Implications, (2006).

    Specific Relief Act 1963 (India).

    Transfer of Property Act 1882 (India)

  • 47

    COLOMBIA COUNTRY REPORT

    Matteo Mandrile*

    (Microfinance Research Officer, International Development Law Organization)

    Emilio Garcia Rodriguez*

    (Associate Professor, Universidad Sergio Arboleda; Director, Emilio Garca Abogados

    Asociados)

    Daniel Mauricio Alarcn Lozano

    (Legal Director, CREDIVALORES CREDISERVICIOS)

    1. Introduction

    In Latin America, consumer protection has become a central topic of debate as the

    microfinance industry continues to grow in terms of clients and products. In 2009,

    under its Legal Empowerment Program financed by the Bill & Melinda Gates

    Foundation, IDLO identified the need to increase awareness of principles which

    protect consumers' rights in the microfinance industry and to promote the

    implementation of these principles. This document summarizes the results of the

    research work conducted in Colombia in collaboration with Universidad Sergio

    Arboleda.

    Over the last decade in Colombia, new public policies and regulations have been

    adopted to raise levels of access to credit and to strengthen financial consumer

    protection. Before 2009, protection mechanisms for financial consumers were

    derived from regulations contained within the Organic Statute of the Financial

    System, various regulatory decrees and Circulars of the Financial Superintendence.

    After the enactment of Law 1328 of 2009, a comprehensive framework of consumer

    rights and obligations for financial entities supervised by the Financial

    Superintendence was established, including regulations on the minimum information

    that should be provided to consumers, the prohibition of abusive clauses, procedures

    for resolving complaints and penalties.

    The analytical research summarized in this report was intended to test whether the

    regulatory framework and its practical application to microfinancial entities'

    relationships with consumers provide adequate protection in the pre- and post-

    contractual stages. The research also assessed whether collection practices

    implemented by the institutions that offer microfinance provided adequate consumer

    protection. To these ends, IDLO conducted surveys and interviews with three

    The authors want to thank IDLO and the Business School of Universidad Sergio Arboleda for their

    support throughout our research. We want to extend special thanks to Dr. Luis Angel Madrid Berroteran, professor at Universidad Sergio Arboleda, for translating the research into English. Finally, we thank all the stakeholders interviewed during the field research, who provided strong support for this project; this research would have been impossible without them. Notably, among the microfinance institutions managers and officials were: Rafael Fernando Orozco Vargas and Andrs Mauricio Novella of Bancama; Orlando Toro Maldonado of Banco Caja Social Colmena; Alejandro Mosquera Arbelez of Bancolombia; Jorge Luis Mayans of ProCredit; Efrn Lozano of Banco Agrario de Colombia; Mauricio Osorio of Crezcamos; Daniel Melndez and Maria del Carmen Salas of FinAmrica; Miriam Paredes of Oportunidad Latinoamrica Colombia; James Javier Saavedra of FMM; and Manuel Olaga of FMM Bucaramanga. Among the Judges were: Elber Narango, Alba Luca Goyeneche, Diego Fernando Salas, Esteban Vargas Benavides, and Martha Ins Daz Romero.

  • 48

    different stakeholder groups: microfinance institutions (bank and non-bank), clients,

    and the judiciary.

    The research found that microfinance consumer protection regulations made

    adequate provision for the protection of consumers and that the supervisory

    infrastructure appears to be adequately resourced. However, in some instances,

    debt-collection practices failed to comply with rules or policies because some staff

    members who manage customer relationships lacked knowledge of written rules and

    policies.

    Overall, it is important to highlight that the regulatory framework is applicable only

    to supervised financial institutions. It does not apply to non-bank financial

    institutions, which are not supervised even though they play an important role in the

    provision of microcredit. Thus, non-bank financial institutions are not subject to

    requirements relating, for example, to minimum contractual content, abusive

    clauses, permissible collection practices or dispute resolution mechanisms.

    Consumer protection can only be achieved when financial institutions provide

    consumers with relevant, clear and timely information, and when consumers who

    consider that a financial entity has treated them unfairly have access either to the

    courts or to effective alternative dispute resolution systems. This papers conclusion

    includes some operational suggestions and regulatory proposals to respond

    effectively, efficiently and economically to the needs of Colombian microfinance

    consumers, especially when dealing with non-regulated financial institutions.

    2. Protection of the Financial Consumer in Colombian Legislation and

    Regulation

    2.1 Consumer Protection in Colombias Financial Services Sector

    Since 2000 in Colombia, important changes were made in how public policies are

    developed, strategies are implemented, and regulations are issued to increase credit

    access levels and to strengthen consumer protection laws for financial consumers.1

    To place the principal characteristics of relevant institutional and normative

    frameworks in context and to explain the level of consumer protection in Colombias

    financial services sector, it is important to describe the sectors main regulatory and

    supervisory public authorities. Two executive branch institutions regulate Colombias

    financial services sector: the Ministry of Finance and Public Credit (Ministerio de

    Hacienda y Crdito Pblico or MHCP), which draws-up credit policies, regulates the

    financial industry based on congressional laws and directly intervenes in the financial

    sector in accordance with its constitutional powers, and the Superintendence of

    Finance of Colombia (Superintendencia Financiera de Colombia or SF), which has

    the mandate to develop constitutional functions assigned to the President regarding

    the supervision of the management, use and investment of funds raised from the

    public. Its purpose is to maintain stability and public trust in the sector. The

    Congress, for its part, is responsible for passing laws that regulate financial

    activities.2

    1 Laws 590 of 2000, 1151 of 2007 and 1328 of 2010 and Decrees 2233 of 2006 and 4590 of 2008. 2 In Colombia, Financial Law is formed from a set of constitutional, legal and administrative regulations applied to financial institutions. The finance system is made up of financial intermediaries, the stock market, insurance companies, and authorities involved in financial markets, such as the Ministry of

  • 49

    The key players channelling microcredit resources in Colombia include banks and

    financial cooperatives, which are regulated by the Financial Superintendence. In

    addition, there are financial institutions or financial cooperatives (other than banks),

    which are entities that are not authorised by law to take deposits from the public and

    are therefore not regulated by the Financial Superintendence.

    Figures consolidated as of May 2010 as part of the government program Banca de

    las Oportunidades (the Opportunity Bank) show that non-bank financial

    institutions earn double the number of microcredit investments equivalent to less

    than 25 times the legal monthly minimum wage (LMMW)3, compared to controlled

    financial entities. For loans between 25 and 1204 times the LMMW, controlled banks

    make more investments.5

    As far as microfinance regulation is concerned, some incentives to encourage loans

    to micro, small and medium-sized enterprises (in Spanish, MIPYMEs) are noteworthy.

    Law 590 of 2000 defines microcredit as the MIPYME funding system, and grants

    benefits to financial intermediaries and organisations specialised in MIPYME

    financing that channel resources for loans of less than 25 times the LMMW. The law

    authorises them to charge fees and commissions of either 7.5 percent or 4.5

    percent6, depending on whether the loan is below or above four times the LMMW, to

    compensate any additional costs. Decree 919 of 2008 defines microcredit as a loan

    granted to a MIPYME whose global debt does not exceed 120 times the LMMW, and

    whose total outstanding loans from the same financial institution are not worth more

    than 25 times the LMMW.

    For purposes of this research, the term microcredit is not used in the strictly legal

    sense explained above. Instead, the term microcredit will be used in a broader

    manner to refer to a financial product offered by banking and non-banking

    institutions to different borrowers, including MIPYMEs in the informal sector. This

    type of microcredit requires specialised management from the lending institution to

    provide ongoing support and advice on finance matters, and a personalised banking

    relationship with clients.

    Regulations have been issued that allow the provision of financial services through

    agents called non-bank correspondents (Corresponsales no Bancarios).7 These

    regulations created a new class of savings accounts called electronic savings

    accounts (Cuentas de Ahorro Electrnicas). In this regard, in July 2007, Congress

    enacted Law 1151, which included the National Development Plan for the presidential

    period 2006-2010. Article 70 of this law states that one of the governments main

    objectives was to allow the low income sector access to banking services. It thus

    called for the implementation of low-cost savings accounts, exempt from the

    compulsory investment requirement, and created incentives for financial institutions

    to offer such products.

    Finance and Public Credit, the Bank of Colombia, the Financial Superintendents Office and the Financial Institutions Guarantee Fund. 3 Law 590, Article 29. Approximately $7,100 in 2010. 4 Approximately $34,200 in 2010. 5 See http://www.bancadelasoportunidades.gov.co/contenido/contenido.aspx?catID=300&conID=690. 6 Superior Council of Microenterprise (Consejo Superior de Microempresa), Resolution 01, 26th April 2007. 7 Decree 2233 of 2006.

    http://www.bancadelasoportunidades.gov.co/contenido/contenido.aspx?catID=300&conID=690

  • 50

    In addition to allowing entities to charge loan fees on top of interest fees (which are

    subject to legal limits)8, other policies have been implemented to improve the access

    of low-income populations to financial services. These include centralising policies on

    financial inclusion in the Opportunities Banking Investment Program (Banca de las

    Oportunidades)9 and the creation of microcredit rediscount lines.10

    2.2 Financial Consumer Protection: A Legal and Regulatory Overview

    The Colombian regulatory framework to protect financial consumers seeks to

    improve consumer confidence in the sector, by ensuring that they receive sufficient,

    timely and accurate information and feedback on any complaints they may lodge. It

    also provides protection against: fraud; lack of diligence or misrepresentation of

    services on the part of financial entities offering the loan products; misleading

    advertising; and abuse of financial institutions' position of power.

    Before 2009, protection mechanisms for financial consumers came from regulations

    contained within the Organic Statute of the Financial System, various regulatory

    decrees and Circulars of the Financial Superintendents Office.11 Law 1328 of 2009

    introduced a new level of protection for financial consumers, with two main

    components: the Defender of the Financial Consumer and the System for

    Attending to the Financial Consumer (SAFC). The former is responsible for resolving

    complaints and conflicts between financial entities and their clients (that the financial

    entity fails to resolve to the satisfaction of the client), and serving as a mediator to

    ensure the just application of legal and contractual regulations. The SAFC imposes

    requirements on financial institutions with regard to establishing policies aimed at

    protecting consumers. In addition, the Financial Superintendents Office has a

    Consumer Protection Directorship, which coordinates the implementation of public

    policy and the monitoring of tools used by financial entities to adequately address

    their clients needs. The recent regulations laid down in Decree 2555 of 2010 also

    help to promote the legal rights of financial consumers.

    For supervised financial institutions and their clients, Law 1328 of 2009 established a

    series of consumer rights, special obligations of the entities, and the minimum

    information that should be provided to consumers. Additionally, it also introduced a

    series of consumer obligations, known as Self-protection practices on the part of the

    financial consumer. Although the consumers failure to follow these obligations does

    not entail the loss of any of their rights, these practices are an important element of

    consumer protection.

    In addition, Law 1328 of 2009 prohibited abusive clauses in financial contracts and

    abusive practices that threaten the consumers interests. The law established a list of

    unfair terms and practices in relationships between financial entities and consumers.

    The following are considered abusive clauses:

    8 Law 590, Article 39. 9 Decree 3078 of 2006. 10 Law 1328, Article 38. 11 Among other regulatory decrees, noteworthy are Decree 690 of 2003 and Decree 4759 of 2005, concerning the so-called Client Defender, which is available for clients of financial entities controlled by the Superintendence of Finance. Legal Basic Circular 7 of 1996, Chap. VI, modified by External Circular 15/2007. Since the enactment of Law 1328 of 2009, the Client Defender has been renamed Defender of the Financial Consumer (see section 1.4).

  • 51

    Limiting or removing the exercise of financial consumer rights;

    Shifting the burden of proof to the detriment of the financial consumer;

    Leaving blank spaces in the contracts, unless there is a detailed letter of

    instruction to complete these; and

    Limiting the contractual rights of financial consumers and the duties of

    controlled entities, or exonerating, mitigating or limiting the responsibility of

    such entities in a manner that will be detrimental to the financial consumer.

    The Financial Superintendents Office is at liberty to add other abusive clauses to this

    list or to define new practices as abusive. Law 1328 of 2009 also ruled that abusive

    clauses in a contract are void as far as the financial consumer is concerned.

    The following are considered abusive practices:

    Conditioning financial consumers by encouraging them to use, or invest in,

    products or services directly provided by the supervised MFI or by its affiliate

    institutions, which are not necessary for the loan;

    Initiating or renewing a service without the request or explicit authorisation of

    the consumer; and

    Shifting the burden of proof in cases of fraud to the financial consumer.

    If an MFI undertakes an abusive practice, the Financial Superintendents Office can

    sanction the MFI and order it to refrain from undertaking the practice.

    Colombia lacks specialised courts or judges for resolving financial disputes or for

    protecting the rights of financial consumers. Similarly, there are no small case judges

    for such disputes, only for resolving criminal matters. Consequently, only ordinary

    judges (municipal judges, circuit judges, court judges and Supreme Court judges)

    have the jurisdiction to resolve disputes between financial entities and their

    consumers. This takes place without prejudice to extra-judicial proceedings, which

    may be taken to the Defender of the Financial Consumer. The Defenders decisions

    are not legally binding for the financial entity, unless the entity has adopted them as

    binding in its policies or unless this has been explicitly agreed in advance with the

    client.

    2.3 Consumer Protection in Transactional Regulation

    2.3.1. Financial Contracts

    Contracts used by regulated financial entities must be clear and comprehensible and

    must be available for prior reading and acceptance by consumers. Such documents

    should contain the terms and conditions of products and services, the rights and

    duties of both parties, the interest rate, fees or commissions charged, and how these

    are determined.12

    Financial entities must provide consumers with a loan repayment plan, which sets

    out the exact value of each payment, together with the split between repayment of

    the principal and interest. This is consistent with Basic Legal Circular, Title II,

    Chapter 1, Numeral 1.1.1.(h)(9) which states: When the nature of the loan means

    that the total payments, including principal and interest, can be established, the

    entity will provide the client with a payment projection. This clearly establishes how

    the loan will be repaid, distinguishing capital and interest in each of the payments.

    12 Law 1328, Article 7.

  • 52

    Financial services contracts do not need to be registered to be binding. However, real

    estate collateral contracts, such as mortgages, do need to be registered for

    completion.13 The regulations do not impose any restrictions based on gender or

    education, though they do provide that minors under the age of 18 may not enter

    into financial services contracts.14

    The Financial Superintendents Office must approve the standard contracts used by

    regulated MFIs and, where contract clauses are not clear, the latter are interpreted

    in favour of the financial consumer. The Financial Superintendents Office also

    requires regulated institutions to publish the contracts on their websites and to

    provide clients with the following:

    Background information to permit proper comparison with other options

    available in the market.

    The consequences of breaching a contract (through failure to make payments,

    late payments, etc.), Law 1328, Article 9.

    Reference to the existence of the Defender of the Financial Consumer, Law

    1328, Article 7 (a). Regulated MFIs should also state whether they accept the

    Defenders decisions as binding, and the range and types of complaints to

    which this applies.

    Following the conclusion of the contract, financial institutions must notify the

    customer before making any changes in the contracts conditions. If they fail to do

    so, the financial consumer may cancel the contract unilaterally without any sanctions

    or penalties.15

    There are no specific financial sector regulations that exempt consumers from

    payment obligations in cases of force majeure (such as serious illness or other

    circumstances). However, any dispute over contractual imbalance should be treated

    as covered by the Trade Law, which would lead to the review of the contract due to

    unforeseen circumstances after completion.16

    Finally, the debtor can possibly invoke corporate insolvency mechanisms, which aim

    to restore and protect the enterprise as an economic entity through reorganisation

    and judicial liquidation, permitting the normalisation of credit relations through the

    payment of obligations or liquidation of assets.17

    2.3.2. Credit Conditions

    Regulations set limits for individual credit transactions made by financial institutions.

    In general, when a credit transaction does not include a guarantee other than the

    borrower's equity, the financial institution cannot lend more than 10 percent of the

    latters equity. If there is a guarantee admissible under current regulations, loans of

    up to 25 percent of the lenders equity may be made.18 However, if the loan

    13 Colombian Civil Code, Article 2434. 14 Colombian Civil Code, Article 1504 and Law 27 of 1977. 15 Law 1328, Article 10. 16 Commercial Code, Article 868. 17 Law 1116 of 2006. 18 Decree 2360 of 1993.

  • 53

    applicant owns more than 10 percent of the financial institutions shares, credit

    transactions are prohibited.19

    Regulated limits on interest rates that may be charged on loans indicate another

    mechanism of financial consumer protection. The interest charged can only be up to

    1.5 times the Current Bank Rate (Inters Bancario Corriente or IBC), certified by

    the Superintendence of Finance for the corresponding period. If no interest rate is

    stipulated in the contract, then the IBC applies. If the borrower defaults, the creditor

    cannot charge interest in excess of 1.5 times the interest rate specified in the

    contract, and in any case it cannot exceed 1.5 times the IBC. An interest charge

    above this rate is considered the crime of usury.20 The law states that any

    commission or fee charged shall be deemed as interest.21

    2.3.3. Guarantees

    Regulations establish the conditions required for contracts to serve as records of

    loans granted by regulated financial institutions. Regulations state that the loans

    must be backed by collateral worth the value of the loan. Several guarantees are

    accepted: mortgages, security schemes, cash deposits, trust funds or guarantees

    granted by companies that have shares in the stock market, etc.22

    Since the regulations do not stipulate additional limitations on guarantees, financial

    institutions may or may not choose to hold the collateral. When the creditor decides

    to hold the collateral, it will then incur depreciation expenses. In any instance of

    default, the lending institution must pursue judicial proceedings in order to sell the

    collateral and cover the debt.

    The Financial Superintendents Office stipulates that financial institutions must have

    a Credit Risk Management System (CRMS). Controlled institutions must keep records

    of loan guarantees in order to mitigate the risk of economic loss in the event of

    default, among other reasons.

    2.3.4. Savings Deposits

    With regard to savings, financial institutions are obliged to provide consumers with

    regular information on the funds deposited. Consumers are free to transfer their

    savings between institutions. There are no regulations limiting the fees that financial

    institutions may charge for opening and managing accounts. Savings accounts must

    not be overdrawn. For checking accounts with an approved overdraft, the institution

    may charge overdraft interest up to the maximum default interest calculated on the

    amount of overdraft. It is illegal to charge fees for failure to maintain a minimum

    account balance.

    Savings deposits are insured by the Financial Institutions Guarantee Fund (Fondo de

    Garantas de Instituciones Financieras or FOGAFIN). The Funds main objective is

    to promote depositors' confidence in the financial system. It offers a guarantee on

    deposits up to 20 million Colombian pesos (COP) per depositor23, for each financial

    institution registered with FOGAFIN.

    19 Decree 1886 of 1994. 20 Commercial Code, Article 884. Modified by Law 150 of 1999. Criminal Code, Article 305. 21 Law 45 of 1990, Article 68. 22 Decree 2360 of 1993. 23 $10,960 in August 2010.

  • 54

    2.4 Consumer Protection in Non-transactional Regulation

    The Congress and the countrys regulatory and supervisory bodies have recently

    issued a series of standards relating to credit risk analysis, the advertising of

    financial products and the treatment of customer information by financial institutions

    and their agents (known as non-bank correspondents or corresponsales no

    bancarios). These are mandatory standards only for entities supervised by the

    Financial Superintendents Office and do not apply to non-bank entities. Although

    this difference between supervised and unsupervised institutions could be deemed

    unfavourable to the customers of non-bank entities, in practice it has had a positive

    impact on the development of microfinance in Colombia.24

    2.4.1. Credit Risk Analysis

    The principal objective of the mandatory standards is to protect the deposits received

    from the public, through regulations which relate to the means by which public

    savings are captured and the financial institutions that capture them. The regulations

    do not apply to non-bank entities that offer financial products (such as loans) but are

    not authorized to take deposits.

    Regulations on loans made by financial intermediaries seek to ensure that credit is

    granted only to individuals with sufficient financial stability to pay them back, thus

    preventing excessive financial risk-taking with consumers deposits. As for

    institutions that do not take deposits from the public, they only need to comply with

    regulations regarding the maximum interest rate.

    Financial institutions are required to undertake a credit risk analysis using various

    documents submitted by the client. Colombias Tax Code stipulates that, when

    granting loans, financial intermediaries must look carefully at the Declaration of

    Income or Certificate of Income and Withholdings, and use this to clearly establish

    the applicant's income level in the previous year.25 In practice, this limits the ability

    of financial institutions to offer financial products to people who may have enough

    income to meet credit obligations, but who cannot prove it due to informal work

    activities. The same rules do not apply to unsupervised entities offering loans or

    micro-loans, because they are not obliged to base their risk analysis on such

    documents.

    The Financial Superintendents Office also stipulates that financial institutions must

    check their loan applicants credit history. However, given the difficulties in accessing

    the financial system for the first time, the vast majority of poor people accept loans

    from family, friends or institutions (often at rates above the usury limit) to finance

    their businesses, and as a result, they often have not established a credit history.

    Nonetheless, the absence of a formal credit history does not mean that informal

    businesses cannot obtain funding from a regulated entity. In practice, MFIs deem a

    borrowers non-appearance in a credit bureau database as a higher risk factor that

    lowers the applicants credit rating. This, in turn, leads financial institutions to set

    aside more capital during the loan period. Since this can be costly, financial

    24 This point on the development of microfinance in Colombia is analysed in more detail in the Conclusion section. 25 Article 620, Tax Code; Article 120, paragraph 1, Organic Statute of the Financial System (Estatuto Orgnico del Sistema Financiero).

  • 55

    institutions usually transfer that cost to the client through interest rates that are

    higher than what their most creditworthy clients are charged.

    The regulation regarding the treatment of database information does not limit the

    type of data that can be stored: other than number of loans, borrowing behaviours,

    instances of default, etc., credit bureaus can hold additional information associated

    with a borrowers ability to pay. It may include information that is not related to

    strictly financial matters, such as borrowers previous behaviour in paying utility bills,

    the purchase of mobile telephones or the receipt of government subsidies. This

    information can be used by financial institutions to conduct credit risk analyses,

    focusing on financial and non-financial records of potential customers. The Habeas

    Data Law26 lays down comprehensive principles regulating the processing, storage

    and publication of such information, mainly referring to the veracity and restricted

    circulation of data. It also stipulates that the information should be handled securely

    and published within specified time limits.

    2.4.2. Non-bank Correspondents

    Since 2006, the Colombian Government has been working hard to increase the

    financial systems coverage. This process has been led by the government program

    Banca de las Oportunidades, which has among its objectives the presence of a non-

    bank correspondent in each of the countrys 1,100 municipalities. At present, there

    are active non-bank correspondents in more than 315 municipalities previously

    without any provision of formal financial services. This leaves fewer than five

    municipalities without formal financial coverage. Non-banking correspondents mainly

    serve lower income citizens.

    It is important to note that when financial institutions make the decision to expand

    their networks through non-bank correspondents, they must take the necessary

    technological and security measures to ensure that transactions made by such

    means are recorded in real time, minimising the risk of fraud. Financial institutions

    must compensate consumers for any losses they have incurred as a result of fraud or

    error.

    The regulations that apply to financial products which are sold through non-bank

    correspondents are the same as those applying to institutions supervised by the

    Financial Superintendents Office. Consumer protection regulation, especially

    provisions contained in recent financial reform (Law 1328 of 2009), stipulates that

    clients and potential clients should receive clear, correct and concise information on

    the conditions pertaining to financial products. As for advertising, financial

    consumers must receive standardised information so that they are able to compare

    the costs and terms of the products of different institutions.

    2.5 Supervision and Enforcement

    The current regulatory framework in Colombia provides several safeguards against

    unfair treatment by regulated financial institutions of their clients. As mentioned

    above, some of these safeguards (namely the Defender of the Financial Consumer

    and the Financial Superintendents Office) do not apply to clients of non-regulated

    entities, which are used mostly by low-income customers. Customers of these

    26 Law 1266 of 2008.

  • 56

    institutions can enforce their rights only through ordinary courts, in which the

    procedures are long, complicated, and often costly.

    In summary, to resolve their disputes with the MFI, clients of a regulated entity have

    four possible avenues available to them:

    The financial institution itself, which is obliged to respond to consumer

    complaints;

    Under state supervision, the Financial Superintendents Office;

    Ordinary courts; and

    The Defender of the Financial Consumer which, despite being paid by the MFI,

    must by law be objective in its decisions.

    Unfortunately, these mechanisms are limited. The processing of complaints by the

    Defender of the Financial Consumer (even though handled in a swift and timely

    manner), as well as the ultimate decision made by the Defender, is not mandatory

    unless the MFI has voluntarily opted for it in its policies. As mentioned earlier,

    regulated MFIs should also state whether they accept the Defenders decisions as

    binding, and the range and types of complaints to which this applies.

    The Financial Superintendent cannot order a financial institution to compensate a

    consumer, because this falls within the exclusive jurisdiction of the judges. Having

    said that, its intervention in cases of abusive practices encourages MFIs to solve

    problems directly with customers. This is because the Financial Superintendents

    Office supervises regulated institutions and has the power to impose penalties

    ranging from warnings to monetary fines. This thus encourages financial institutions

    to resolve a consumers complaint or problem, because the Superintendences

    penalties depend on the attitude of the financial entity in attempting to resolve its

    problems with clients.

    In summary, for a consumer to obtain a decision which obliges a financial institution

    to provide payment or compensation for damages, the intervention of a judge is

    needed. However, as already stated, the judicial process for settling claims is slow.

    There are only a small number of relevant criminal offences. These relate, in

    particular, to banking secrecy violations, excessive charging of interest, and

    improper handling of customer information.

    3. Field Research

    3.1 Methodology Research Design

    The analytical process of research was intended to test the following hypothesis: the

    regulatory framework and its practical application in the consumer-MFI relationship

    provides adequate protection in the pre- and post- contractual stages, as well as in

    the debt-collection processes.

    To test this hypothesis, the research focused on five broad areas:

    1. The relevant regulatory framework for the Colombian financial system,

    including consumer protection;

    2. Possible gaps in the regulatory framework in relation to international

    obligations or accepted international practice;

  • 57

    3. The effective application of the regulatory framework;

    4. The most important areas in which practices are incompatible with the law;

    and

    5. The factors that appear to underlie each major problem.

    Table 1. Research Questions and Methodological Tools

    Research Questions

    Methodological tools

    Regulatory Framework what standards of

    performance are expected?

    What are the legal requirements governing

    lending by MFIs, particularly in relation to

    protection of consumers in the contracting,

    dispute resolution, and debt recovery

    processes?

    Literature Review

    Stakeholder

    Interviews

    Are there any gaps in the regulatory

    framework in relation to international

    obligations or accepted international

    practice?

    Desk analysis

    Stakeholder

    Interviews

    Current Practice what standards of

    performance are being delivered?

    To what extent are current practices

    consistent with legal requirements (or good

    practice more generally)?

    Literature Review

    Stakeholder

    Interviews

    Borrower Survey

    What areas of inconsistency are most

    significant?

    Literature Review

    Stakeholder

    Interviews

    What factors underlie each major problem? Literature Review

    Stakeholder

    Interviews

    To answer these questions and focus on the highlighted areas, IDLO and its local

    counterpart, Universidad Sergio Arboleda, conducted surveys and interviews with

    three different stakeholder groups: MFIs, clients, and the judiciary. Interviews were

    conducted in a consistent manner over a specified time period, and all researchers

    used the appropriate techniques taking into account the information to be collected

    and the Colombian context.

    Structured interviews (surveys) were conducted with consumers. In these surveys, a

    list of predetermined questions was asked to which the respondent could not provide

    responses beyond those offered. For MFI employees and judges, semi-structured

    interviews with open questions were utilised.

  • 58

    To begin, managers and loan officers of 10 MFIs were interviewed.27 They answered

    a 12-question survey, which was aimed at providing an understanding of the

    development of the entity-client relationship in five key areas: the assessment of the

    ability to repay and the protection of clients against over-indebtedness; calculation of

    the applicable interest rate, as well as the information on credit terms provided to

    the client; debt-collection practices and internal policies on them; the mechanisms to

    address customers complaints; and how information about individual consumers is

    stored and used.

    The interviews targeted both managers and loan officers in order to assess whether

    regulatory requirements, together with the consumer protection policies of each

    institution, are effectively applied to the customer. In addition, the interviews also

    tried to assess whether each category of staff is sufficiently familiar with these

    regulations and policies. The outcome was that some gaps between MFI policies and

    their implementation by staff became apparent, as will be discussed in the

    conclusion.

    After conducting these interviews, 100 customers of the 10 sample institutions were

    surveyed to learn first-hand about their perceptions of the issues mentioned above.

    The surveys included these questions:

    a) How do customers become aware of financial products and services offered by

    MFIs?

    b) What documents are required in order to obtain credit?

    c) Are contractual terms and conditions clear? Do customers have the

    opportunity to check and understand them and do they keep a copy of the

    contract?

    d) What are the consequences of late payments, collection practices, the use of

    refinance instruments, insolvency, default or bankruptcy mechanisms?

    Finally, the research also included surveying five judges to determine the precise

    scope of disputes between financial institutions and their clients in areas such as:

    Issues that regularly come before the courts;

    Possible causes of delay in legal processes;

    Issues relating to the appearance in court of financial clients as lawsuit

    defendants;

    Causes of lawsuits launched by customers;

    Their views on the content of financial contracts, together with possible gaps.

    In the sections below, field research results are divided and presented by different

    categories of stakeholders.

    3.2 Microfinance Institutions (MFIs)

    Ten financial institutions were selected to build a sample with different legal status

    (banks, foundations, NGOs) and relevant market share.

    For each MFI, at least two employees were interviewed: a credit officer and a

    manager (or a legal advisor with a comprehensive knowledge of the credit

    27 The study involved six MFIs regulated by the Superintendence of Finance and four unregulated non-profit institutions. See Table 2 Sample of MFIs.

  • 59

    application process). In each of the entities, loan contracts, together with other

    documents which were commonly provided to the customer, were reviewed.

    Table 2. Sample of MFIs28

    MFIs Gross Loan Portfolio (in

    Millions of USD)

    Number of

    Active

    Borrowers

    Regulated

    Bancama 240.7 285,765

    Bancolombia Microfinanzas 28.5 28,665

    Banco Caja Social Colmena 2,507.7 976,229

    ProCredit Colombia 42.3 10,700

    FinAmrica 80.3 42,575

    Unregulated

    Crezcamos 6.3 8,148

    Women's World Banking Cali 229.1 179,701

    FMM Popayn 203.9 293,079

    Oportunidad Latinoamerica

    Colombia

    1.2 6,406

    Source: MIX Market, 2009

    Based on the interviews conducted using the methodology described above, it

    appeared clear that the most common microfinance product in the Colombian market

    is individual credit for working capital or fixed asset acquisition.29 Two organisations

    offer a form of collective or group credit that consists of providing loans to a number

    of micro-entrepreneurs for a joint productive project, where each borrower is jointly

    liable.30

    3.2.1. Assessment of Clients Ability to Repay

    All entities explained that they carry out a preliminary analysis of the customers'

    credit history through information provided by credit bureaus, but they pointed out

    28 The nine MFIs listed in Table 2 report their data to the Microfinance Information Exchange, Inc. (MIX), which is the source of information contained in the table for gross loan portfolios and for active borrowers. Banco Agrario de Colombia, the 10th MFI in the research sample, is not included in Table 2 because it does not report its data to MIX. However, since Banco Agrario de Colombia is a supervised financial institution, the website of the Superintendence of Finance shows some aggregated microcredit figures: in Banco Agrario de Colombias financial statements as of September 2010, the sum of microcredits linked to various types of guarantees accounted for a total of $1,155.4 Million. 29 Under Article 38 of Law 590 of 2000, the Government encourages the establishment of credit lines for the capitalization of micro, small and medium-sized enterprises (in Spanish, MIPYMES), which can be designated for loans and investments. However, as mentioned previously, the concept of microcredit for the purpose of this investigation is broader, with institutions providing loans for other purposes. 30 The public bank Banco Agrario de Colombia, for joint productive projects in the agricultural sector; and the foundation Oportunidad Latinoamerica Colombia, for microenterprise projects.

  • 60

    that this is not the sole decisive factor in deciding whether or not to grant a loan.

    Taking into account that micro-entrepreneurs often do not keep regular accounts, a

    sales adviser usually visits the customer and its premises in order to analyze cash

    flows and the cost structure, thereby establishing the client's ability to repay a loan.

    Nonetheless, supervised financial institutions still have to require the client to submit

    a Declaration of Income or Certificate of Income and Withholdings, as explained in

    the non-transactional regulation section (1.3.1.).

    3.2.2. Information on Interest Rates and Payments

    When they grant credit, financial institutions provide their customers with

    information on applicable interest rates and the repayment process. This information

    is expressed in nominal and real terms and is accompanied by an amortization plan

    that contains the value of each payment, together with the split between repayment

    of the principal and interest payments, or any additional fees or charges. This type of

    disclosure appears to be particularly appreciated by clients, who indicated that the

    amortization plan enables them to understand the main terms of the loan because it

    reflects clearly their monthly payments.

    3.2.3. Collection Practices

    Before granting a loan, MFIs make clear to a borrower the collection practices used

    in the event of default; with few exceptions, they also have written debt-collection

    principles and policies. Out of 10 entities interviewed, seven reported that they had a

    written collection policy and the remaining three claimed to have a collection policy,

    though it had not been set down in writing. In our research, financial institutions

    supervised by the Superintendence of Finance seemed to have a clearer

    understanding of debt-collection behaviors which the Superintendence, in its Circular

    N. 48 of 2008, had categorized as acceptable or unacceptable.

    3.2.4. Consumer Complaint Mechanisms

    Under Colombias regulations, client options for submitting complaints, claims and

    petitions are the Defender of the Financial Consumer (for supervised MFIs), free

    phone lines, mailboxes located in their premises, attention centres, and web pages,

    among others. All institutions interviewed reported that they have written procedures

    for the complaint-handling process.

    3.2.5. Use of Client Information

    Finally, all sample entities use credit bureaus, both for assessing clients ability to

    repay and reporting them in case of default. The credit bureau report mechanism is

    recognized by the MFIs as a tool which helps to persuade borrowers to repay,

    because clients know that failure to do so would affect their ability to obtain credit in

    the future. The entities indicated that they do not share customer information.

    3.3 Clients

    Ten clients were interviewed for each of the sample MFIs. In the overall client

    population, 60 percent of consumers were non-defaulting borrowers and 40 percent

    were defaulting.

  • 61

    Universidad Sergio Arboleda School of Business undertook an initial pilot with a small

    group of respondents. Despite a few changes that were made to tailor some

    questions for the Colombian financial sector, the pilot showed that questions were

    clear and that the correct range of possible answers had been included for each of

    them.

    3.3.1. Choice of Microfinance Institution

    More than 70 percent of microfinance consumers choose their financial institution on

    the basis of recommendations from friends or relatives, or following contact with

    salespersons. Advertising and other mechanisms have relatively low impact on how

    an institution is selected.

    Figure 1. Choice of MFI by Non-Defaulting Borrowers

    Figure 2. Choice of MFI by Defaulting Borrowers

    8.93%

    37.50%

    37.50%

    16.07%

    How did you first

    hear about the MFI

    services?

    Advertising Salemen/Sales advisers Friends Other

    11.11%

    44.44%

    27.78%

    16.67%

    How did you first

    hear about the MFI

    services?

    Advertising Salemen/Sales advisers Friends Other

  • 62

    3.3.2. Credit Application Requirements

    Clients indicated that MFIs required them to provide identity documents, and that

    credit history is normally checked. Some customers claimed that financial institutions

    also required documents other than financial statements or work certificates - this is

    because micro-entrepreneurs are usually informal workers who do not keep regular

    accounting books. Finally, most interviewees agreed that the time between the start

    of the loan application process and contract signing did not exceed two weeks.

    3.3.3. Knowledge of Contract Terms and Conditions

    An overwhelming majority of respondents stated that contractual conditions were

    adequately explained when they applied for credit, and only about 5 percent of

    defaulting borrowers disagreed with this. Likewise, the vast majority of customers

    also stated that they received a copy of the financial contract and were allowed to

    keep it.

    Figure 3. Contract Delivery to Non-Defaulting Borrowers

    Figure 4. Contract Delivery to Defaulting Borrowers

    96.36%

    3.64% Were you given a

    copy of the loan

    agreement?

    No Yes

    85.71%

    14.29% Were you given

    a copy of the

    loan agreement?

    No Yes

  • 63

    Figure 5. Contract Conservation by Non-Defaulting Borrowers

    Figure 6. Contract Conservation by Defaulting Borrowers

    Finally, most of the interviewed clients stated that they received sufficient

    information from financial institutions about interest rates, loan repayment terms,

    MIPYME fees and commissions, and the consequences of late payments. However,

    surveys show that there were gaps in the information provided to clients regarding

    amendments of contracts, opportunities for redress, ways of expressing

    dissatisfaction with the institution, and protection of consumer data. Also, the

    information provided by MFIs to clients was not always conveyed in plain language,

    i.e., in a manner that is easy for poor people to comprehend, some of whom struggle

    with illiteracy.

    3.3.4. Consequences of Late Payment

    Raising the applicable interest rate and the imposition of collection fees were the

    consequences of late payment. According to clients, the most frequently used

    87.04%

    12.96% Do you still have

    a copy of this

    contract?

    No Yes

    52.94%

    47.06% Do you still have a

    copy of this

    contract?

    No Yes

  • 64

    collection strategies were phone calls, visits (given the personal and relational

    character of microcredit), and written communications. On a smaller scale, MFIs

    used electronic means such as e-mails and text messages. Collection communication

    used by MFIs alerts the debtor to the consequences of a negative report to the credit

    bureaus. To a lesser extent, it warns of possible legal actions to secure the collection

    and enforcement of the collateral, or seeks additional guarantees.

    About 60 percent of customers said they did not receive proposals from the MFIs to

    restructure their loans or begin a new payment plan; additionally, 80 percent of the

    customers did not request debt restructuring. In this regard, it is important to note

    that more than 70 percent of the customers who actually asked for restructuring

    received a favorable response from the MFIs.

    Figure 7. Loan Restructuring for Defaulting Borrowers: Proposals by MFIs

    Figure 8. Loan Restructuring for Defaulting Borrowers: Proposals by Clients

    37.14%

    62.86%

    No Yes

    Did the MFI make a

    proposal to

    restructure the loan

    or suggest a new

    payment schedule?

    20%

    80% Did you require

    debt

    restructuring?

    No Yes

  • 65

    Figure 9. Loan Restructuring for Defaulting Borrowers:

    MFIs Answers to Clients Requests

    Fewer that than 23 percent of defaulting borrowers said that they had asked for debt

    relief. They turned to the institutions management or to the Defender of the

    Financial Consumer for debt relief, and did not use other channels such as

    consumers associations, private legal advice or legal assistance. Almost 95 percent

    of defaulting borrowers reported that they did not know how to use mechanisms of

    bankruptcy or default. Finally, more than 72 percent of clients said that they did not

    have problems with the return or release of the guarantee once they had ceased to

    be in default.

    3.4 Judiciary

    Five judges with extensive experience in handling cases of disputes between financial

    institutions and customers were selected and interviewed:

    Alba Lucia GOYENECHE, Judge Nineteen, Civil Circuit of Bogot;

    Elber NARANJO, Judge Tenth , Civil Circuit of Bogot;

    Diego Fernando SALAS, Judge Thirteen Civil Municipal;

    Stephen VARGAS BENAVIDES, Judge First Civil Municipal; and

    Martha Ines DIAZ ROMERO, Judge Fourteen Civil Municipal.

    3.4.1. Recurring Controversies Between MFIs and Customers

    All five judges agreed that collection processes of financial institutions represented

    most of the cases brought to their attention. In 95 percent of cases brought by

    financial institutions against their customers to recover the loan, the decision is

    favorable to the MFI.

    Cases where the customer is the claimant are few, and they do not exceed 10

    percent of the total volume of disputes that judicial offices receive. Most of the cases

    0.00%

    28.57%

    71.43%

    If so, what was

    the answer of the

    MFI?

    An agreement was reached on a new payment schedule or loan

    The MFI was open to renegotiate but no agreement was reached

    The request of debt restructuring was denied

  • 66

    initiated by customers against MFIs involve legal actions to protect the information

    reported to credit bureaus, defending the constitutional right of Habeas Data.31 In

    this regard, the judges said that the Habeas Data Law had been an appropriate tool

    to protect clients from the misuse of information held by credit bureaus as well as

    from incorrect reports, or from permitting these reports to be kept beyond the time

    indicated by law.

    3.4.2. Probable Causes of Process Delay

    Unpaid debts are dealt with by Colombias civil courts and processes for collection

    (executive in nature) are set by law to last from six months to a year, according to

    the established procedure. However, delays are the norm and the main reasons for

    the extension of the process, which sometimes lasts up to three years, are the

    following:

    High number of cases tried before courts.

    Multiplicity of legal actions that can be used by parties, most of which can be

    appealed.

    Legal procedures aimed to make the judicial ruling effective, which involve an

    appraisal of the collateral, its auction, and the adjudication of the property to

    the bidder or the bank.

    The party that initiates the court action assumes the expenses incurred during the

    course of the legal proceedings, but the losing party must reimburse the costs after

    the announcement of the verdict.

    3.4.3. Defence Capability of Financial Consumers

    Debtors who lack sufficient funds to pay legal counsel may turn to clinics at

    universities law schools, which provide free legal advice; moreover, civil procedure

    law allows legal relief on poverty grounds. Therefore, judges may designate a lawyer

    to represent the debtor. Over-indebtedness is not a valid defence for debtors to

    avoid fulfilling their obligations.

    If the debtor does not appear before the court, the judge must designate a legal

    representative to ensure that the right of defence is safeguarded. The judges

    indicated that in the enforcement (executive) processes, it is often necessary to

    publicly summon the defendant and designate a legal representative, as defendants

    frequently cannot be located, notified and brought before the court.

    According to the interviewed judges, the only instances in which a consumer

    defendant appears to be the winning party are those involving prescription of the

    legal security. The judges said that evidence admissible to prove payment has to be

    documentary (receipt of payment), thereby noting that customers usually have

    difficulty providing this kind of evidence because they do not retain such

    documentation. However, it is possible to request from the financial institution an

    internal record relating to the debtor that could serve the same purpose as other

    types of documentary evidence.

    31 Law 1266 of 2008.

  • 67

    3.4.4. Content and Clarity of Financial Contracts

    As for contract content, four out of five judges argued that the large number of

    clauses, the size of the letter, and confusing technical language are the main causes

    behind low-income clients difficulties in analyzing contracts. Moreover, there is a

    perceived structural deficiency due to the nature of contracts of adhesion, as the

    clients do not usually read the entire contract because they cannot alter them. In

    this respect, they recommended these improvements to the contracts structure:

    clearer, simpler and more concise writing; more information on credit conditions;

    and a special focus on the applicable interest rates.

    Finally, the judges did not notice problems with the effectiveness of collateral and

    found them adequate to ensure loans. However, microcredits are often based on

    personal guarantees, which are more difficult to enforce because they involve

    pursuing guarantors or co-signers who, in most cases, have no assets. However, the

    judges interviewed highlighted that under Colombian law, MFIs could pursue assets

    of the debtor other than the collateral, as all his assets are considered a "general

    guarantee to creditors, subject to the relevant statutory limits relating to garnishing

    wages, pensions, etc.

    4. Conclusions and Recommendations

    4.1 Conclusions

    The following concluding remarks are organized into sections that respond to the

    issues linked to the main hypothesis, namely that the Colombian regulatory

    framework for financial consumer protection and its practical application provides

    adequate protection in the pre- and post- contractual stages and in debt-collection

    processes.

    4.1.1. Regulatory Framework

    Regulation on financial consumer protection has been strengthened with the

    enactment of Law 1328 of 2009, which provides a series of definitions and principles,

    consumer rights and obligations that apply to supervised MFIs and their clients. This

    law includes regulations on minimum information to be provided to consumers, the

    prohibition of abusive clauses, procedures for resolving complaints, and penalties for

    any breach of the legislation. Yet this regulatory structure is applicable only to MFIs

    supervised by the Superintendence of Finance, thus leaving an important regulatory

    gap for non-bank financial institutions, such as foundations and NGOs, which play a

    significant role in the allocation of microcredit. Additionally, successful policies and

    regulations that were introduced to increase access to microcredit by MIPYMEs32

    were not accompanied by more robust regulation to protect consumers in their

    dealings with non-bank financial institutions.

    As for the content of the contracts, apart from requiring that they must be clear,

    legible and made available to the consumer, the law is very vague about the so-

    called minimum content, which in turn means that the relationship between the MFI

    and the consumer is usually formalised through a blank promissory note with a letter

    of instruction. There is no standardised loan contract, though both regulated and

    32 Law 1328/2009, Law 590/2000, Law 1151/2007; Decree 1119/2003, Decree 2233/2006.

  • 68

    non-regulated institutions usually provide a loan amortization schedule to the

    customer. However, the client often ignores concepts such as effective interest rate,

    default penalties and other financial and legal concepts that might be detailed in the

    contract.

    Both regulated and non-regulated institutions report information to credit bureaus

    and use these to assess credit applications, as all financial institutions use credit

    history reviews as a mechanism to prevent over-indebtedness. The majority of MFIs

    adequately assess the capacity of the borrower to repay the loan, using legal

    mechanisms that permit them to charge a fee and a commission. The former covers

    the cost of granting the loan, while the latter is paid for the MFIs analysis of the

    proposed credit transaction, considering that there is commonly an absence of

    financial statements and tax certificates. It is likewise linked to specialised assistance

    to entrepreneurs, as well as technical visits to verify the actual situation of clients

    business activities. The field investigation has shown that these practices are

    essential in the provision of credit to micro enterprises, both by regulated and

    unregulated MFIs. Nonetheless, requiring regulated entities to check the Declaration

    of Income or Certificate of Income and Withholdings remains a significant obstacle to

    granting credit to informal customers. When an informal debtor has no elements to

    prove his ability to repay and the MFI decides to proceed with the loan, a portfolio

    provision (Loan Loss Reserve) equal to the total amount of the credit must be set

    aside, thus increasing the costs for the MFI.

    4.1.2. Regulatory Gaps

    This research has clearly shown that regulated financial institutions have adequately

    developed mechanisms for consumer protection. This is in contrast to the lack of

    specific regulations for other types of entities that do not fall under state legislation

    because they do not take deposits from the public, though they offer other financial

    services such as credit. The absence of specific regulations for non-supervised MFIs

    means that there are various regulatory gaps in areas such as minimum contractual

    content, abusive clauses, permissible collection practices, and dispute resolution

    mechanisms. The protection of consumers against possible abuses of non-bank

    financial institutions is thus quite limited. Unfortunately, the consumers most at risk

    from this lack of regulation are the poor, because non-bank financial institutions

    usually target the low-income population.

    4.1.3. Effective Application of the Regulatory Framework

    Customers of regulated financial institutions can bring disputes to the financial entity

    itself, the Defender of the Financial Consumer, the Financial Superintendents Office,

    or to ordinary judges. According to Article 24 of Law 795 of 2003, all supervised

    entities must have a unit dedicated to financial client protection (Defensora del

    Cliente Financiero), which is responsible for receiving complaints and ruling on them.

    The Defender of the Financial Consumers decisions have no binding force. Decisions

    from the Financial Superintendent can only point out administrative violations by the

    supervised entity, but cannot rule in favour of consumers. Judges, who have full

    authority to settle conflicts between institutions and their customers, may declare

    void abusive clauses and order payment or compensation. Clients of both regulated

    and unregulated financial institutions can take legal action to resolve disputes arising

    from their contractual relationships. However, while judges enjoy a broad authority

  • 69

    to fix and order payment of damages, the judicial process is slow and courts are

    chronically congested. This results in delays in dispute resolution processes.

    The Colombian judicial system lacks specialized courts for resolving financial

    disputes. Additionally, there are no small claims processes for financial disputes. In

    the interviews with judges, it appeared evident that cases initiated by financial

    consumers were few because most cases were for collection purposes, where the MFI

    sought to recover the outstanding amount. The most common cases brought by

    customers concern excessive charging of interest,33 protection of information

    reported to credit bureaus or privacy issues regarding personal data.

    4.1.4. Gaps Between Law and Practice

    As for debt-collection procedures, responses during the field research revealed a

    gap, in some instances, between regulation and MFI policy management, due to lack

    of knowledge of written rules and policies by some salespersons who manage direct

    customer relationships. Finally, it is important to highlight that it may be too early to

    state that Law 1328 of 2009 is contributing to strengthened consumer protection in

    Colombia, because the specific regulations on consumer protection only came into

    force on 1st July 2010.

    4.2 Recommendations

    Looking at a possible follow-up project in Colombia, this research could be expanded

    to rural areas, as the field work mainly focused on urban consumers. A special focus

    on the rural population would possibly generate additional knowledge on the most

    common problems that vulnerable customers face as clients of small local institutions

    that are not subject to the regulation of the Superintendence of Finance.

    Colombian non-bank financial institutions offer wide access to microcredit resources,

    though they are not subject to the Superintendence of Finances regulation and

    supervision. Indeed, one of this studys key recommendations is the standardisation

    of financial consumer protection to include MFIs not regulated by the

    Superintendence of Finance. Furthermore, there is a need to incorporate the

    Superintendence of Industry and Commerce in this broader regulatory framework.

    This Superintendence currently has general competence in the area of consumer

    protection, but it lacks a clear legal framework to investigate possible violations of

    the rights of customers of non-bank financial institutions. Finally, this broader legal

    framework should clearly define the minimal information to be provided to the client

    and the basic content of a standard loan contract.

    The ability to offer microcredit should be the same for both non-bank and bank

    institutions. The Declaration of Income or the Certificate of Income and Withholdings

    are not always available for informal entrepreneurs, in which case the informal

    entrepreneur is unable to obtain a loan from a regulated institution. Thus, informal

    entrepreneurs tend to obtain loans from non-bank financial institutions. This

    33 In Colombia, when a stipulated remunerative or term interest has not been determined, the current bank rate as certified by the Superintendence of Finance is adopted, and default interest is equal to one and half times the current bank rate. If interest is higher than these amounts, the creditor loses all interest received in excess, and pays an amount of equal value as a sanction. In such cases, the debtor may request the immediate reimbursement of the sums paid in excess. When it comes to regulated MFIs, the Superintendence of Finance has the power to order such a reimbursement; for non-regulated MFIs, a civil court would have to rule on it.

  • 70

    difference between regulated and non-regulated MFIs could be overcome by

    specifying, in the case of micro enterprises, that ability to repay could be assessed

    by regulated institutions on the basis of specialised technical assistance and technical

    visits and that it is not necessary to obtain a Declaration of Income or a Certificate of

    Income and Withholdings. This technical assistance could allow MFIs to define loans

    granted to micro entrepreneurs as low risk, thus avoiding the need for MFIs to

    accumulate big loan loss reserves for micro loans granted to informal entrepreneurs.

    In terms of dispute resolution alternatives available to customers, it is recommended

    that the same mechanisms should be made available to customers of both bank and

    non-bank financial institutions. The lack of mechanisms available to clients of non-

    bank institutions (e.g., the Defender of the Financial Consumer) is a concern for the

    entire industry, as is the reluctance to delegate judicial power to administrative

    bodies such as the Superintendence of Industry and Commerce, which adopts legal

    decisions under the legal condition of res judicata. This would be a critical and

    essential aspect of any regulatory reform, as the interviews with judges revealed

    that very few financial consumers take legal action due to the legal systems

    structural problems (a large volume of cases that often leads to long delays).

    Some combination of the following alternative solutions, which are not mutually

    exclusive, would represent new and concrete opportunities for the strengthening of

    the Colombian legal framework, as well as advancing the legal empowerment of poor

    clients:

    Assign judicial functions to the Consumer Protection Division of the

    Superintendence of Industry and Commerce;

    Establish a Defender of the Financial Consumer for non-bank financial

    institutions;

    Introduce a special expedited process with specialised Judges;

    Establish a special expedited process with small claims Judges; and

    Any other instrument that would contribute to the justice reform proposed by

    the current Government (for instance, the granting of judicial powers to

    notaries).

    In general, to establish a comprehensive consumer protection regulatory framework

    for financial services, Colombia may also consider the following recommendations:

    Prohibiting reckless lending (similar to the provisions in South Africas

    National Credit Act (NCA)). The South African Act protects consumers from

    reckless lending, and provides them with an understandable credit agreement

    in plain language and several other consumer protections.

    Requiring financial services firms to explain clearly to potential borrowers the

    key features (including any fees, commissions or other charges) of products

    and services.

    Ensuring clear, fair and full disclosure of interest rates and charges (e.g.,

    APRs or total cost of credit).

    Ensuring that debt recovery expenses charged to the consumer, if any, are

    reasonable.

    Requiring that any advice given by a financial services entity to a consumer

    should be suitable for the consumer and take into account his or her

    circumstances.

    Prohibiting conditional sales. A conditional sale is an arrangement in which a

    buyer takes possession of an item, but the title remains with the seller until

  • 71

    some condition is met, such as payment of the full purchase price.

    Instituting a cooling off period for certain loans, e.g., loans above a certain

    value and for a duration greater than a specified period of time.

    Requiring that financial firms issue financial statements to consumers at

    stated intervals.

    This section of proposals represents a shortlist of tools that would help Colombia

    achieve further development of its financial sector, and eventually sustainable

    economic growth by responding effectively, efficiently and economically to the legal

    needs of the poor. The authors wish that at least some of these tools become part of

    policy reforms and initiatives of the current national Government over the next four

    years.

  • 72

    References

    Laws and Regulations

    Congress of the Republic of Colombia,

    Civil Code

    Congress of the Republic of Colombia,

    Law 27 of 1977

    Congress of the Republic of Colombia,

    Commercial Code

    Congress of the Republic of Colombia,

    Organic Statute of the Financial

    System

    Congress of the Republic of Colombia,

    Law 45 of 1990

    Congress of the Republic of Colombia,

    Tax Code

    Congress of the Republic of Colombia,

    Law 590

    Congress of the Republic of Colombia,

    Law 795

    Congress of the Republic of Colombia,

    Law 1151

    Congress of the Republic of Colombia,

    Law 1266

    Congress of the Republic of Colombia,

    Law 1328

    Congress of the Republic of Colombia,

    Law 1395

    Government of Colombia, Decree 2360

    of 1993

    Government of Colombia, Decree 1886

    of 1994

    Government of Colombia, Decree 690

    of 2003

    Government of Colombia, Decree 4759

    of 2005

    Government of Colombia, Decree 2233

    of 2006

    Government of Colombia, Decree 3078

    of 2006

    Government of Colombia, Decree 1119

    of 2008

    Government of Colombia, Decree 4590

    of 2008

    Government of Colombia, Decree 2555

    of 2010

    Superintendence of Finance, Legal

    Basic Circular

    Superior Council of Microenterprise,

    Resolution 01 of April 26th 2007

    Websites

    http://www.bancadelasoportunidades.gov.co

    http://www.fogafin.gov.co

    http://www.minhacienda.gov.co

    http://www.superfinanciera.gov.co

    http://www.bancadelasoportunidades.gov.co/http://www.fogafin.gov.co/http://www.minhacienda.gov.co/http://www.superfinanciera.gov.co/

  • KENYA COUNTRY REPORT

    Angela Ondari*

    (Kenyan Advocate; Executive Director, Safe House and Empowerment Center

    (SHEC))

    Arthur Goujon

    (Microfinance Researcher, International Development Law Organization)

    1. Introduction

    1.1 Country Overview

    Kenyas financial sector is one of the broadest and most developed in sub-Saharan

    Africa (SSA). There are 45 financial institutions, including 43 commercial banks and

    two mortgage finance companies. These banks, along with the Kenya Post Office

    Savings Bank, make up Kenyas formal banking sector and serve 22.6 percent of

    Kenyas adult population of 17.4 million, according to survey results published in

    early 2009.1 Kenyas financial services sector also has approximately 3,600 saving

    and credit cooperatives (SACCOs) and up to 100 microfinance institutions (MFIs).2

    Kenyas Central Bank reported that as of December 2008, the 36 retail MFIs

    (excluding commercial banks) registered with the Association of Microfinance

    Institutions (AMFI) had 1.44 million active deposit accounts/clients at their 825

    branch offices, an increase of over 400,000 active deposit accounts/clients from

    2007. Excluding commercial banks, the value of total deposits was $202 million at

    the end of 2008, compared to $151 million a year earlier. These institutions had 1.27

    million active loan clients at the end of 2008, an increase of over 30 percent from the

    previous year, and a total of $443 million in gross loan portfolio.3

    Non-bank financial institutions, including microfinance institutions (MFIs), savings

    and credit cooperatives, and mobile phone service providers, serve another 17.9

    percent of the population, bringing the total served by formal financial services to

    40.5 percent.

    In addition to traditional forms of microfinance, mobile banking has rapidly expanded

    access to financial services in Kenya since Safaricom, the Kenyan affiliate of global

    mobile telecommunications provider Vodaphone, launched its M-PESA service in early

    2007. M-PESA allows customers to access an electronic payment and store-of-value

    system through their mobile phones, and offers cash deposit and withdrawal access

    at 16,900 Safaricom outlets throughout Kenya, nearly half of which are located

    The authors would like to thank all those who contributed to gathering information for this publication:

    In Kenya: Strathmore University, for granting us access to their law and microfinance library; and

    At IDLO: Aline Sjourn, Aleksandra J. Kasprzycka, Aaron Pittman, and Elizabeth Acorn. The authors would also like to thank the editors who helped review and complete this paper. 1 Mix Market: Microfinance in Kenya: Country Briefing, at http://www.mixmarket.org/mfi/country/Kenya/report. 2 Financial Sector Deepening, 2009, at http://www.fsdkenya.org. 3 Mix Market: Microfinance in Kenya: Country Briefing, supra note 1.

    http://www.themix.org/publications/2009-africa-microfinance-analysis-benchmarking-reporthttp://www.themix.org/publications/2009-africa-microfinance-analysis-benchmarking-reporthttp://www.mixmarket.org/mfi/kposbhttp://www.mixmarket.org/mfi/kposbhttp://www.centralbank.go.ke/downloads/bsd/annualreports/bsd2008R.pdfhttp://www.mixmarket.org/networks/amfi-kenyahttp://www.mixmarket.org/networks/amfi-kenyahttp://www.safaricom.co.ke/http://www.vodafone.com/index.VF.htmlhttp://www.safaricom.co.ke/index.php?id=745

  • 74

    outside of urban centers. As of January 2010, M-PESA had 9 million customers.4 In

    May 2010, Safaricom and Equity Bank announced a partnership to enable M-PESA

    customers to open a new Equity Bank M-KESHO savings account that can be

    accessed through their mobile phones.5 A few MFIs are also starting to develop

    partnerships with telecommunication providers to operate some of their transactions

    through mobile phones.

    Another 26.8 percent of Kenyans rely on the informal financial sector, including non-

    governmental organizations (NGOs), self-help groups and individual unlicensed

    money lenders, and 32.7 percent of the population does not use any form of financial

    services.6

    Only recently have the SACCOS and the MFIs started to enter each others markets.

    As of this writing, the two types of financial institutions still offer different financial

    products to different type of customers. For this reason, and because MFI and

    SACCOs present strong differences in products and governance structures, this

    research focused on the microfinance sector exclusively; the other providers are

    discussed to provide a benchmark of practices.

    SACCOs traditionally serve a population of employees, both in the private and the

    public sectors, as well as agricultural workers. In contrast, MFIs are concentrated in

    Kenyas larger cities, most with headquarters in Nairobi. SACCOs target a less-

    affluent population, which traditionally would be the customer base of informal

    financial services providers and Rotating Savings and Credit Associations (ROSCAs).

    As a result, the average active loan amount for SACCOs ranges from Kenyan Shilling

    (KShs) 21,000-50,000 and KShs 100,000-500,000, while for the MFIs, loans are

    rarely above 20,000 KShs.7 MFIs currently serve only a relatively small part of the

    Kenyan population8, but their market target of financially excluded population

    actually represents roughly 35.2% of Kenyas estimated adult population of 17.4

    million in 2006.

    Several MFIs have filed applications for a license with the Central Bank of Kenya to

    become deposit-taking institutions, with six receiving licenses to become deposit-

    taking institutions as of this writing. As a result, MFIs in Kenya principally offer

    credit.

    As of May 2010, non-deposit-taking microfinance institutions are not under the

    jurisdiction of the Central Banks microfinance regulations, and as such they would

    fall either under the SACCO category supervised by the SACCO Societies Regulatory

    Authority (SASRA), or the informal microfinance category, which is unregulated

    except for the licensing required of all NGOs in Kenya. The Central Bank is currently

    consulting with a variety of industry stakeholders to determine the best practices for

    incorporating non-deposit-taking MFIs into its regulatory framework.9

    4 Ibid. 5 Ibid. 6 Ibid. 7 Financial Sector Deepening, 2009, supra note 2. 8 Only 1.7% of adults use MFI services according to Financial Access in Kenya, Financial Sector Deepening (FSD) Kenya, October 2007. 9 Mix Market: Microfinance in Kenya: Country Briefing, supra note 1.

  • 75

    MFIs also offer some technical assistance services, and in a few instances, insurance

    products, mainly through partner institutions. Finally, one MFI developed the

    capacity to offer a card-for-payment system. As a result, we examined these issues,

    but focused on small-loan issuance.

    2. Protection of the Financial Consumer in Kenyan Legislation and

    Regulation

    2.1 Financial Consumer Protection: A Legal and Regulatory Overview

    Under Kenyas 2002 Constitution, the banking industry is governed by the

    Companies Act, the Banking Act, the Central Bank of Kenya Act, and the various

    prudential guidelines issued by the Central Bank of Kenya (CBK). In 2005, another

    constitution was drafted, but subsequently rejected by Parliament. In August 2010, a

    new constitution was approved by two-thirds of registered Kenyan voters in a

    national referendum. The new constitution commits the nation to protecting

    consumers.

    However, Kenyan regulations still provide a dispersed and incomplete framework for

    protecting consumers of microfinance services. For instance, the Microfinance Act of

    2008 forbids institutions to provide services in a fraudulent or reckless manner

    detrimental to the institutions interest or the interest of depositors or the general

    public, and includes know your customer requirements. The Act, besides those

    general statements, provides a framework for consumer rights.

    Various elements relevant to consumer protection can be found in regulations

    relating to specific aspects of microfinance transactions. Relevant legal sources

    include, but are not limited to:

    Chapter 28 - Chattels Transfer Act

    Chapter 23 - The Law of contract

    Chapter 526 - Auctioneers Act

    Civil Procedure Rules of 2010

    Chapter 128 - Chief Authority Act

    Chapter 504 - Restrictive Trade Practices, Monopolies and Price Control

    Act

    Additional consumer protection recommendations were made in 2007 when Member

    of Parliament Jakoyo Midiwo introduced the Jakoyo Consumer Protection Draft Bill.

    The text had been debated for a few years, and was yet to be adopted in 2010, when

    Kenyas change of constitution led to the drafting of an entirely new text.

    The 2010 draft was still under discussion when this paper was completed. As

    currently drafted, it introduced the objective of reducing disadvantages for low-

    income customers, as well as those geographically isolated, who represent the

    microfinance industrys traditional market, but does not provide specific tools for

    financial services delivery. Rather, it established a list of general consumer rights:

    Equality in consumer markets

    The right to choose

    Disclosure and information

    Fair and responsible marketing

    Fair and honest dealings

    http://www.africansea.org/ASEA/Download/Revised%20ASEA%20Memo%20and%20Articles%20of%20Association%2010%203%202006.pdfhttp://www.microfinancegateway.org/p/site/m/template.rc/1.9.25632http://www.centralbank.go.ke/downloads/acts_regulations/cbk_Act.pdfhttp://www2.centralbank.go.ke/publications/guides/pguides/index.htmlhttp://www.centralbank.go.ke/

  • 76

    Fair value, good quality and safety

    The right against unfair commercial practices

    Supplier accountability

    Consumer education and participation

    Access to redress.

    Although it is difficult to anticipate how courts will interpret this text, court cases

    could possibly lead to improved protection for microfinance consumers. As clients

    state their arguments in front of a judge, courts may make decisions that could

    possibly establish legal precedent.

    The most interesting suggestion in the Act concerns the establishment of new

    redress mechanisms: a consumer claim tribunal, an alternative dispute resolution

    mechanism, and the submission of claims to the Consumer Protection Commission

    (which, notably, can be directly initiated by consumer associations).

    Finally, the Association of Microfinance Institutions of Kenya (AMFI) has, in the past

    few years, begun to develop a code of ethics for the microfinance industry. This

    work, however, has not yet been completed.

    2.2 The Institutional Framework

    Kenya still lacks a regulatory entity with a full and complete mandate to protect

    microfinance consumers. The mandate of the Central Bank of Kenya (CBK), for

    instance, is elusive and incomplete. According to the Banking Act:

    () the Central Bank may have regard to the previous conduct and

    activities of the person concerned in business or financial matters and,

    in particular, to any evidence that such person () has contravened

    the provisions of any law designed for the protection of members of

    the public against financial loss due to the dishonesty or incompetence

    of, or malpractices by, persons engaged in the provision of banking,

    insurance, investment or other financial services

    This article seemingly provides the CBK a particular mandate with regard to

    consumer protection, but two remarks can be made. First, Kenya still lacks a law

    that ensures protection of consumers of financial services, so this mandate is yet to

    be defined. Second, the article seems to refer to dishonesty and malpractice, which

    would give a limited scope to consumer protection.

    More promising, the 2010 Consumer Protection Bill proposed establishing a

    Consumer Protection Commission with a mandate not only to promote and expedite

    the creation of consumer rights, but also to monitor the enforcement of the existing

    regulations, promote consumer associations and settle consumer complaints.

    Interestingly, the draft would allow the Commission to receive complaints from

    parties involved in disputes as well as from consumer protection groups.

    3. Field Research

    The empirical study of consumer protection practices in Kenya covers contracting

    and disclosure, collateralization, and debt collection practices.

  • 77

    3.1 Contracting and Disclosure Practices

    Contracting practices for microfinance lending involve significant consumer

    protection issues. This includes advertising practices, first contacts with the

    institution, the creation of self-help groups, as well as the drafting and signature of

    loan contracts. Our main conclusions are: first, that the commercial practices of

    microfinance institutions often leave customers with incomplete information on the

    financial commitments they are undertaking; and second, that the contractual

    elements are sometimes drafted with too much legal and practical imprecision,

    redundancies or incoherence, that can result in increased confusion about the terms

    of a particular transaction.

    3.1.1. Commercial Practices of MFIs and Informational Asymmetries

    About 90% of loans provided by microfinance institutions are still provided through

    the group lending methodology (although this might be changing recently for some

    institutions).

    Self-help groups usually include five to ten clients. The group is encouraged by the

    MFI to constitute itself as an association and register at the office of the District

    Gender & Social Development Officer (DGSDO). That said, many groups seem to

    ignore this requirement, although the proportion of associations to informal groups is

    difficult to measure. The creation of a group, in any case, is formalized by the

    drafting and signature of a constitution.

    Provisions in the groups constitution usually establish the governance mechanisms

    of the group by defining the tasks that will be the responsibility of the chairman, a

    secretary, a treasurer, a discipline master, a loan committee, and a coordinator.

    The constitutions rules also establish the respective annual election process. It also

    contains all rules relevant to the life of the group, such as the frequency and agenda

    of meetings, as well as the fines imposed in case of failure to attend a meeting or the

    misbehavior of a member.

    Group constitutions are negotiated at the time the group is formed, with the

    assistance of the MFIs loan officer and often from templates provided by the MFI.

    From the few documents we observed, it appears that, despite best efforts, group

    constitutions frequently employ unclear language and, sometimes, confusing

    arrangements involving the respective duties and rights of members.

    Besides the drafting shortcomings, the members of each group effectively waive part

    of their contractual rights, as a three-quarters majority is sufficient to make

    decisions for the entire group. The group constitution provides the right for each

    member to leave the group at any time, but this becomes increasingly difficult in

    practice, as a members deposits with the institution grow and as a member becomes

    the guarantor of one or more loans.

    Indeed, the groups members put their deposits in one account at the MFI. Each

    member retains proof of his or her savings (saving deposit slips). While savings

    deposits are taken, loans can then be assigned to individual members with the

    approval of the loan committee. The group always acts as a guarantor for each loan,

    with each member risking his or her deposits to guarantee the loan balance. Each

    debtor also pledges a certain number of chattels (electrical domestic goods or cattle,

    for instance) listed in the loan agreement.

  • 78

    For individual loans, the relationship with the MFI is more straightforward. Clients

    contact the MFI with a loan request and up to three guarantors are required. In case

    of individual loans above a certain amount, chattels might be registered.

    Some issues were noted during the field study, but they remain anecdotal and

    difficult to measure. For instance, some MFIs report a serious problem with the way

    they handle information in their portfolio. Most of the information of each group is

    retained by a specific loan officer. When that officer leaves, the MFI loses crucial

    information about the groups specific issues. Also, interviews have revealed

    instances of fraud committed by loan officers, such as creating fictional client

    records. Consequently, stricter management of an MFIs information system may

    possibly limit abuses against the microfinance consumer.

    3.1.2. Advertising and Price Display

    One particular concern that was addressed by the field study was the type of

    information accessible by potential customers of financial products available to them.

    Interestingly, the research showed that advertising seems to play a relatively small

    role in comparison to word of mouth and direct marketing.

    Figure 1. How did you first hear of the MFIs services?

    To educate their clients, the MFIs we interviewed seem to provide mandatory

    training (from one to eight hours) to each group as a condition for obtaining financial

    services, but this often seems to be limited to the assistance provided by the loan

    officer in drafting the group constitution.

    In general, the customers we interviewed seemed to have a positive assessment of

    the information that was communicated to them before they signed their loan

    contracts. Still, 40 percent of the customers we interviewed said that the information

    that was provided by the MFI was either incomplete, or not entirely clear. A more

    Advertisement,

    5%

    Friends, 88%

    Salesperson,

    6%

    Other,

    1%

    Advertisement

    Friends

    Salesperson

    Other

  • 79

    detailed questionnaire might reveal the particular points that microfinance

    consumers might want to see featured in their initial training and meeting with an

    MFI representative.

    Figure 2. Was the agreement clearly explained to you?

    Figure 3. Was the information provided to you accurate?

    3.1.3. Contracts

    We found that the establishment of contracts is one of the weak points of the MFI-

    customer relationship. Legal and financial illiteracy exists on both sides the client

    and, to a lesser extent, the loan officers and sometimes it leads to diminished

    clarity and efficiency in the drafting. Second, copies of contracts rarely seem to be

    Yes, 94%

    No, 5% Other, 1%

    Yes

    No

    Other

    Completely

    accurate, 56%

    Accurate but

    incomplete,

    31%

    Accurate but

    unclear to me,

    13%

    False, 0%

    Completely accurate

    Accurate but

    incomplete

    Accurate but unclear

    to me

    False

  • 80

    given to microfinance consumers. Clients are left with a copy of the payment

    schedule, but never with the copy of the contract itself.

    If a member defaults, the group chairman will receive a copy of the loan agreement.

    The chairman will then use the loan agreement to exert pressure on the defaulter

    and, in some instances, collect the chattels.

    Figure 4. Were you given a copy of the loan agreement?

    Figure 5. Do you still have a copy of the loan agreement?

    Providing copies of loan agreements is a cost-free measure to protect the rights of

    microfinance consumers, and this should rapidly become a standard in the industry.

    Yes, 38%

    No, 61%

    Other, 1%

    Yes

    No

    Other

    Yes, 15%

    No, 84%

    Other, 1%

    Yes

    No

    Other

  • 81

    3.1.4. Interest Rate Disclosure

    The Banking Act of 2006 partially regulates the cost and remuneration of savings

    accounts, but financial institutions are not required to disclose their interest rates. As

    a result, each category of financial institution can use a different calculation method

    or presentation method, making it nearly impossible for consumers to compare

    prices.

    While banks usually provide information on interest rates and other fees on a

    percentage basis, a savings account opened at a SACCO will generate dividends,

    which are unpredictable and impossible to compare with traditional interest rates or

    fees.

    As far as credit is concerned, both MFIs and SACCOs generally calculate interest

    through repayment schedules, detailing the total amount to be repaid every month.

    The FSD and the Central Bank of Kenya conducted a joint research initiative in 2009

    to elaborate on scenarios designed to promote transparency in the disclosure of

    interest rates. One of the studys key findings is that most consumers did not

    comprehend interest rates when applying for a loan.

    As a consequence, the report suggests a phased approach to reforming interest rate

    disclosure, starting with the total cost of credit (TCC) and/or repayment schedules

    (RS), and then moving onto an annual percentage rate (APR). Further, the

    implementation of industry-wide standards for interest rate calculation and

    mandatory disclosures needs to be done in collaboration with all other financial

    services providers.

    3.2 Collateral in Kenyan Microfinance

    Almost all microcredit transactions given in Kenya are accompanied by a pledge of

    security by the borrower. The field study revealed the cost, length and complexity of

    establishing and enforcing security interests. The inefficiency of those tools has

    several damaging consequences for the microfinance consumer, notably:

    It limits access to credit;

    It increases the cost of credit; and

    It might lead microfinance institutions to securing their portfolio with

    illegal or redundant security interests.

    In our opinion, providing MFIs with a framework for registering and collecting

    security interests that is easy, innovative, and, at the same time, strict, is an

    efficient - albeit paradoxical - way to increase access to finance and strengthen the

    protection accorded to the Kenyan microfinance consumer.

    3.2.1. Typology of Microfinance Collateral

    We asked MFI clients what type of collateral they had to secure in order to get credit.

    Most of them had to find guarantors (members of the group in group lending

    situations) and assets to pledge.

  • 82

    Figure 6. What type of collateral did you use, if any?

    Excerpt from a loan agreement

    List of chattels

    ITEM Serial # Value (KSHS)

    TV 24 inches 298739827397398 30.000

    10 tables Mica and wood 8.000

    5 Cows NA 30.000

    Security interests can also be of a mixed nature. For instance, group members, or

    guarantors in general, might be required to present a list of chattels to pledge in

    addition to their personal liability.

    Aside from collateralizing loans, peer pressure is another powerful pressure tool used

    by MFIs to ensure that group members repay loans. Besides their personal

    guarantee in such cases, the entire group knows that if one person in the group

    defaults, it will prevent everyone from obtaining additional financing from the MFI.

    This mechanism, often used by microfinance institutions across the globe, is a

    powerful incentive in case of monopolies or quasi-monopolies. It loses some of its

    significance in Kenyans urban markets, where other financial providers might be

    available.

    Finally, as far as personal loans are concerned, urban MFIs also tend to charge,

    besides chattels and guarantees, title deeds (real estate) and logbooks (cars) as

    security.

    Personal

    guarantee, 8%

    Mortgage, 0%

    Pledge of

    movable asset,

    92%

    Other, 0%

    Personal guarantee

    Mortgage

    Pledge of movable

    asset

  • 83

    3.2.2. The Issue of Blocked Deposits

    The Microfinance Act of 2008 gives the Central Bank of Kenya the responsibility to

    license and supervise deposit-taking microfinance institutions. So far, six MFIs have

    received a license to take savings deposits. Until 2011, Faulu Kenya was the only MFI

    that had been licensed to take savings deposits.

    While it is true that most of the MFIs collect deposits, they are used as collateral for

    loans and blocked with a fixed deposit certificate. In the MFIs we visited, the ratio

    of collateral to savings is a leverage of 20 percent for individual savings and 30

    percent in case of group guarantee.

    Excerpt from a loan agreement

    About blocked deposits

    I give (the MFI) and its agents authority to use my current and future

    savings to offset my loan or (that) of any other person I have

    guaranteed () this mention is followed by my current savings

    pledged as security: 14,030

    ()

    30 percent of the entire loan amount (is) requested to be deposited as

    savings, which is refundable after the loan amount has been paid.

    Several comments can be made about such deposits. First, according to the

    language used in the loan agreement, it is not clear whether the block applies only to

    a predetermined amount, or also to additional savings deposited in the future.

    Second, since these funds cannot be characterized as savings, the clients who make

    these deposits do not receive interest. Worse, as blocked assets, they represent a

    hidden opportunity cost which is not calculated in the interest rate advertised by the

    MFI. Indeed, frozen deposits would be generating a return if they were placed in a

    bank account, or dividends if they had been placed in an account with a SACCO.

    Third, MFIs that are not licensed by the CBK to accept savings are not subject to any

    prudential supervision, nor do they participate in any savings insurance scheme. As a

    result, and for obvious reasons, they are firmly prohibited from leveraging any

    deposits on their books. Yet, interviews with microfinance practitioners reveal that

    this prohibition is not systematically respected, and that loans, which are covered by

    this portfolio of deposits, are sometimes taken from commercial banks.

    3.2.3. Collateral Regulation 1: The Protection of the Borrower

    The Civil Procedure Act of Kenya grants some protection to the judgment debtor.

    While all his property is liable for attachment and sale to resolve the debt, some

    exceptions are envisaged:

    The necessary wearing apparel, cooking vessels, beds and bedding of

    the judgment-debtor and of his wife and children, and those personal

    ornaments from which, in accordance with religious usage, a woman

  • 84

    cannot be parted, the tools and implements of a person necessary for

    the performance by him of his trade or profession, etc.

    In the same way, an employee cannot pledge more than two-thirds of his or her

    salary to the repayment of his or her debt.

    This regulation was formulated to protect the borrower, but is not necessarily known

    by the public or applied. For example, one judge we interviewed recalled having to

    rule on a dispute involving group members because some of them had forcefully

    removed the tin roof on the house of a defaulting debtor with the intent of selling it

    to recover their debt. Although it is difficult to gather anything more than anecdotal

    evidence on the topic, those examples should suffice to illustrate the need to

    professionalize debt collection and train microfinance institutions and borrowers

    about the law.

    3.2.4. Collateral Regulation 2: Inefficiencies

    FSD Kenya commissioned a study on the shortcomings of the collateral process, its

    costs and delays.10 The first observation of the study relates to the dispersion of the

    legal framework, as there are more than 20 statutes regulating the creation and

    perfection of collateral in Kenya.

    Laws relevant to the collateral process in Kenya (FSD, 2009)

    1) Indian Transfer of Property Act, 1882

    2) Law of Contract Act (Chapter 23, Laws of Kenya)

    3) Registered Land Act (Chapter 300, Laws of Kenya)

    4) Registration of Titles Act (Chapter 281, Laws of Kenya)

    5) Government Lands Act (Chapter 280, Laws of Kenya)

    6) Land Titles Act (Chapter 282, Laws of Kenya)

    7) Sectional Properties Act (Act No. 21 of 1987)

    8) Limitation of Actions Act (Chapter 22, Laws of Kenya)

    9) Companies Act (Chapter 486, Laws of Kenya)

    10) 10 Evidence Act (Chapter 80, Laws of Kenya)

    11) Stamp Duty Act (Chapter 480, Laws of Kenya)

    12) Registration of Documents Act (Chapter 285, Laws of Kenya)

    13) Banking Act (Chapter 488, Laws of Kenya)

    14) Traffic Act (Chapter 403, Laws of Kenya)

    15) Land Control Act (Chapter 302, Laws of Kenya)

    16) Chattels Transfer Act (Chapter 28, Laws of Kenya)

    17) Advocates Act

    18) Notaries Public Act

    19) Arbitration Act (Act No. 4 of 1995)

    20) Agriculture Act (Chapter 318, Laws of Kenya)

    The study also reveals the inefficiency of the registration system, which is still

    manual, dispersed, and does not forbid a client from pledging the same chattel to

    different institutions. Finally, enforcement procedures tend to be lengthy and at a

    cost that is disproportionate to the small loan amounts that the financial institutions

    are trying to recover.

    10 Financial Sector Deepening, 2009, supra note 2.

  • 85

    This defective legislation almost systematically prevents the regular registration of

    chattels by MFIs, and seriously limits the use of mortgages. Interviews with MFIs

    confirmed that chattels are not registered. As illustrated above, they consist of a list

    of assets inserted in the body of the loan agreement. Before the client signs the loan

    contract, the loan officer verifies the existence of the chattels. The chattel document

    is prepared and signed by an advocate only for larger amounts, still with no further

    registration.

    The absence of a satisfactory legal and institutional framework for collateral is often

    cited by practitioners as one of the great obstacles to their commercial development.

    It is obviously one explanation for the weakness, illegality or redundancy of the

    collateral practices we observed in the field.

    3.3 Debt Collection and Judicial Procedures

    Kenyas previous Civil Procedure Code included the possibility of a jail sentence of six

    months for debtors. These practices have been removed in the new Civil Procedure

    Code of 2010. As a result, the debt collection process now principally revolves

    around procedures of foreclosure for chattels and mortgages.

    With the group lending methodology, most of the debt-collection process is

    conducted directly through the group. This model certainly presents many

    operational advantages, but it can also be risky for a borrower, who often fails to

    receive protection from the law in those informal processes.

    A borrower who is in default first receives one, then two warning letters from the

    MFI. A third warning letter is sent to the groups officials, the chairman and the

    secretary. MFIs tend to hire lawyers only to draft the letters and follow the procedure

    for amounts above 100,000 KSH.

    Enforcement of contracts in Kenya requires an average of 40 procedures, usually

    lasting for 465 days, and at a total cost equal to 42% of the claim, according to the

    2011 Doing Business report for Kenya.11 According to the magistrates we

    interviewed, procedural delay can vary from one to two years on average, followed

    by a period of three to six months to enforce the decision, depending on how difficult

    it is to locate the losing party. To enforce a mortgage in court, for instance, the

    procedure can take five years or more. Still, the estimated cost of a judicial

    procedure is around $300, according to the magistrates. The cost is paid by the

    person who loses the case.

    This probably explains why none of the officials at the MFIs we interviewed recalls

    ever going to court for a default. Often, parties reach a private settlement before the

    end of the proceedings. There also seems to be a divide between urban and rural

    areas with regard to access to justice. Yet in general, it has proved particularly

    difficult to draw conclusions on the frequency of cases going to trial. Contrary to the

    assertions of the MFIs, some magistrates we interviewed recalled a few instances in

    which they had ruled on an MFI case. However, independent confirmation of this is

    difficult, as court records are not accessible to the public.

    According to the magistrates we interviewed, most litigation brought by clients

    concerned interest rates, and resulted from poorly drafted contracts.

    11 See http://www.doingbusiness.org/data/exploreeconomies/kenya/#enforcing-contracts.

    http://www.doingbusiness.org/data/exploreeconomies/kenya/#enforcing-contracts

  • 86

    Unfortunately, the borrower often has difficulty finding an advocate to represent him.

    In theory, a party who cannot find an advocate can file a pauper brief to obtain legal

    assistance, but on our visits to courts we observed that many defenders represented

    themselves.

    3.3.1. The Role of Chiefs

    In Kenyas old constitution, chiefs had the right to confiscate property. They

    operated as the administrative police of the state. Chiefs would provide justice for

    small civil issues. According to article 6 of the Chief Authority Act (Chapter 128):

    It shall be the duty of every chief or assistant chief to maintain order

    in the area in respect of which he is appointed, and for such purpose

    he shall have and exercise the jurisdiction and powers by this Act

    conferred upon him over persons residing or being within such area.

    Interestingly, nothing in the Act relates to ruling on civil litigation, let alone debt

    collection. The responsibility of chiefs is linked only to issues relating to public order,

    such as drinking in public, possession of weapons and the prevention of crime.

    Nevertheless, many MFIs have admitted that chiefs played important roles (in

    collaboration with self-help groups or their own branches) in settling difficult cases of

    default.

    The power of the chiefs is a remnant of the countrys colonial history, and has been

    removed by the new constitution of 2010. Citizens are expressing concerns on the

    damage of such changes, with respect to access to justice for small claims.

    For this reason, it seems to us that eliminating the chiefs traditional roles should not

    be done without a careful evaluation of its impact on access to local justice,

    specifically on the issue of replacing the traditional system with a new one that is

    both efficient and fair.

    3.3.2. Auctioneers

    Auctioneers should be, according to law, the only actors authorized to enforce MFI

    collateral. The research team met with several auctioneers to explain the importance

    of making the debt collection process more professional.

    After an auctioneer is called by the lender or the guarantor (the group, in many

    cases), he gives the defaulter a first notice of seven days. It is estimated by the MFIs

    we interviewed that 50 percent of the cases were solved at this stage by negotiating

    with the group. If the defaulter does not give an answer to the auctioneer within a

    week, the auctioneer visits the defaulters house and evaluates the value of his

    chattels. If necessary, the auctioneer can request police escort.

    Auctioneers offer many guarantees which should be considered as protective of the

    consumer. First, they have to undergo a licensing process. Second, every step of

    their intervention (the delays for action, the safety of the storage of the property,

    the advertisement of the auction sales, etc.) is timed and monitored by the law. The

    actions of the auctioneer are subject to appeal to the High Court.

  • 87

    Nonetheless, the field research unearthed some illegalities in contractual language,

    as well as MFI practices. For instance, the following language can be found in a loan

    agreement, in contravention of the law:

    This (asset pledge declaration) form gives (the group) express

    authority to take pledged items of loan defaulters without necessarily

    involving any public or private sector (actor) since the agreement was

    entered (into) between the loan defaulter in arrears and the group.

    Indeed, some MFIs we interviewed admitted that they would threaten to sell their

    clients collateral by advertising them in the MFI offices. According to them, this has

    a strong dissuasive effect on the client, and the sale is rarely carried out.

    Further, in the same loan agreement one can find:

    In case I am late in paying any installment I do hereby authorize (the

    MFI) and/or (name of the group) or their agents to use any means at

    their disposal to recover any late payment from me.

    Such a general waiver dangerously induces confusion over the means actually

    available to the MFI or the group when recovering missing payment. The Law of

    Contract, the Civil Procedure Act and Auctioneers Act already provide a framework

    for debt collection. Therefore, any additional comment in the text of a contract

    should either be a clear reference to the applicable articles or go unstated.

    4. Conclusions and Recommendations

    The following derive from the findings of this paper:

    MFIs should seek legal advice with respect to drafting the constitutions of

    self-help groups, so that they may produce and distribute improved

    documentation.

    Stronger management of the MFI information system is one possible way to

    limit abuses against the microfinance consumer. Channels of communication

    (that go above the loan officer, and enable the consumer and the MFI to

    rapidly settle small disputes) should be established.

    A more detailed questionnaire might inform efforts to improve microfinance

    consumers initial training and meetings with MFI representatives.

    Loan officers should undergo specific legal training on the transactions they

    process.

    Providing a copy of a loan agreement is a cost-free measure to protect the

    rights of the microfinance consumer, and this should rapidly become an

    industry standard.

    MFI should seek specialized legal advice in contract drafting. Lawyers can

    review contracts, clarify the text, avoid redundancies and contradictions, and

    make sure that contractual provisions are in line with the law.

    The Central Bank should continue to promote uniform methods for calculating

    interest rates and the education of the consumer.

    The legislature, in partnership with industry, should streamline collateral

    regulation and provide cheap and simple ways for (a) the registration of small

    assets and (b) associated collection practices.

    The legislature, in partnership with industry, should continue to provide an

    environment conducive to the growth of alternative dispute resolution

  • 88

    mechanisms, and likewise develop small claims procedures that are cheap,

    accessible and fair to the consumer. This can be elaborated within or outside

    the framework of the upcoming Consumer Protection Act.

    Auctions appear to be a valid approach to enforcing microfinance contracts,

    according to our research. Their intervention is framed by the law, and often

    leads to rapid mediation without further foreclosure or procedure.

    Microfinance borrowers should be made more aware of the proper procedure

    and their rights with regard to the foreclosure of chattels, which is both a way

    to empower them and to dissuade defaulters.

    In general, to establish a comprehensive consumer protection regulatory framework

    for financial services, Kenya may also consider the following recommendations:

    Prohibiting reckless lending (similar to the provisions in South Africas

    National Credit Act (NCA)). The South African Act protects consumers

    from reckless lending, and provides them with an understandable credit

    agreement in plain language and several other consumer protections.

    Requiring financial services firms to explain clearly to potential borrowers

    the key features (including any fees, commissions or other charges) of

    products and services.

    Ensuring clear, fair, and full disclosure of interest rates and charges (e.g.,

    APRs or total cost of credit).

    Ensuring that debt recovery expenses charged to the consumer, if any,

    are reasonable.

    Requiring that any advice given by a financial services entity to a

    consumer be suitable for the consumer and take into account his or her

    circumstances.

    Prohibiting conditional sales. A conditional sale is an arrangement in which

    a buyer takes possession of an item, but the title remains with the seller

    until some condition is met, such as payment of the full purchase price.

    Instituting a cooling off period for certain loans, e.g., loans above a certain

    value and for a duration greater than a specified period of time.

    Requiring that financial firms periodically issue financial statements to

    consumers at stated intervals.

    Requiring that notifications be sent to consumers when an institution

    makes changes in the terms and conditions of financial products.

    Requiring proper training, professional standards and supervision of

    relevant staff of financial entities or their agents.

    Requiring that financial entities treat consumers fairly, and enacting

    prohibitions on unfair, deceptive or aggressive practices.

  • 89

    References

    Laws and Regulations

    Described on www.Kenyalaw.org

    Microfinance Act of 2006

    Banking Act of 2006

    Chapter 28 - Chattels

    Transfer Act

    Chapter 526 -

    Auctioneers Act

    Civil Procedure Rules of

    2010

    Chapter 128 - Chief

    Authority Act

    Chapter 23 The Law of

    contract

    Publications

    Definition of a standard

    measure for consumer interest

    rates in Kenya, a scoping

    study, FSD Kenya, March 2009

    Cost of collateral in Kenya/

    opportunities for reform, FSD,

    September 2009

    The strategic directions and

    regulatory support for a strong

    MFI sector, Prof. Njuguna

    Ndungu, Governor, Central

    Bank of Kenya

    http://vle.worldbank.org/bnpp/

    files/TF053594FinancialCoopera

    tivesCaseStudyKenya.pdf

    http://www.accion.org/Page.as

    px?pid=1419

    blogs.warwick.ac.uk/.../the_pro

    spects_of_microfinance.doc

    http://www.fsdkenya.org/pdf_d

    ocuments/10-07-

    12_Annual_Report_2009.pdf

    http://www.fsdkenya.org/pdf_d

    ocuments/10-07-

    21_FinAccess_supply_side.pdf

    http://www.fsdkenya.org/pdf_d

    ocuments/10-10-

    26_KCPA_roadmap_briefing_no

    te.pdf

    http://www.fsdkenya.org/pdf_d

    ocuments/10-07-

    21_FinAccess_supply_side.pdf

    http://vle.worldbank.org/bnpp/files/TF053594FinancialCooperativesCaseStudyKenya.pdfhttp://vle.worldbank.org/bnpp/files/TF053594FinancialCooperativesCaseStudyKenya.pdfhttp://vle.worldbank.org/bnpp/files/TF053594FinancialCooperativesCaseStudyKenya.pdfhttp://www.accion.org/Page.aspx?pid=1419http://www.accion.org/Page.aspx?pid=1419http://www.fsdkenya.org/pdf_documents/10-07-12_Annual_Report_2009.pdfhttp://www.fsdkenya.org/pdf_documents/10-07-12_Annual_Report_2009.pdfhttp://www.fsdkenya.org/pdf_documents/10-07-12_Annual_Report_2009.pdfhttp://www.fsdkenya.org/pdf_documents/10-07-21_FinAccess_supply_side.pdfhttp://www.fsdkenya.org/pdf_documents/10-07-21_FinAccess_supply_side.pdfhttp://www.fsdkenya.org/pdf_documents/10-07-21_FinAccess_supply_side.pdfhttp://www.fsdkenya.org/pdf_documents/10-10-26_KCPA_roadmap_briefing_note.pdfhttp://www.fsdkenya.org/pdf_documents/10-10-26_KCPA_roadmap_briefing_note.pdfhttp://www.fsdkenya.org/pdf_documents/10-10-26_KCPA_roadmap_briefing_note.pdfhttp://www.fsdkenya.org/pdf_documents/10-10-26_KCPA_roadmap_briefing_note.pdfhttp://www.fsdkenya.org/pdf_documents/10-07-21_FinAccess_supply_side.pdfhttp://www.fsdkenya.org/pdf_documents/10-07-21_FinAccess_supply_side.pdfhttp://www.fsdkenya.org/pdf_documents/10-07-21_FinAccess_supply_side.pdf

  • CAMEROON COUNTRY REPORT

    Edwidge Tchaha*

    (General Secretary, Caisse d'Epargne et de Credit du Littoral (CAPCOL))

    Arthur Goujon

    (Microfinance Researcher, International Development Law Organization)

    1. Introduction

    1.1 Country Overview

    The population of Cameroon was approximately 18.2 million in 2009.1 Of this

    population, approximately 40 percent was living below the poverty line, a

    considerable improvement from 1996 when over 50 percent of the population was

    living below it. This percentage varies greatly between rural areas, where about 50

    percent of the population lives, and in Cameroons urban areas, where 22 percent of

    the population resides.

    Because many people in Cameroon have relatively limited access to traditional

    banking, and taking into account the large size of its informal business sector,

    Cameroon is considered an ideal location for microfinance services. Furthermore, as

    Ian Long observed in a recent paper, microfinance can serve as one solution for the

    economic difficulties of the countys poorest citizens.2 That is, Long writes, the

    inherent bottom-up approach of microfinance may have a better chance of

    impacting the lives of Cameroonians living in poverty than other top-down

    approaches, such as foreign aid to the Cameroonian government.3 In fact, Cameroon

    had over 500 officially registered MFIs in 2009, and microfinance is commonly

    regarded as an important influence on the countrys development.4

    2. Protection of the Financial Consumer in Cameroonian Legislation and

    Regulation

    Consumers in Cameroon benefit from all the protections granted by the Civil Code to

    parties that make and implement agreements, as well as some consumer protection

    regulations in a piece of 1990 legislation that established standards for conducting

    commercial activity in Cameroon. Yet Cameroons laws do not provide a broad

    consumer protection framework that specifically regulates banking or other financial

    services, such as microfinance. Complicating matters further, the few laws relating to

    The authors want to thank all those who contributed to gathering information for this report:

    In Cameroon: Jean-Paul Ngoulou and the Association Renfort et Action, Vicaire Ouafo Bepyassi: and

    At IDLO: Aline Sjourn, Aleksandra J. Kasprzycka and Pauline Borczuch. The authors would also like to thank the editors who helped review and complete this publication: Gabriel Nzoyem, Executive Director of ANEMCAM, David Kengne, Microfinance Consultant, DG of Microfinance Academy, Michael Ndikum, Chairman of the Board of CAPCOL, and Vicar Ouafo Bepyassi. 1 IFAD. Cameroon Statistics. Rural Poverty Portal. See http://www.ruralpovertyportal.org/web/guest/country/statistics/tags/cameroon. 2 Long, Ian, "Perceptions of Microfinance in Cameroon: A Case Study of UNICS, Yaound" (2009). ISP Collection. Paper 729. See http://digitalcollections.sit.edu/isp_collection/729. 3 Ibid. 4 Ibid.

    http://www.ruralpovertyportal.org/web/guest/country/statistics/tags/cameroon

  • 91

    the protection of financial services consumers are scattered among Cameroonian civil

    law and some pieces of regional legislation, such as: the Organization for the

    Harmonization of Business Law in Africa (OHADA) Uniform Acts, the Civil Code, and

    the Banking Commission of Central Africa/Central African Economic and Monetary

    Community/Central African Monetary Union (COBAC/CEMAC/UMAC) regulations on

    microfinance activity and banking activity.

    Cameroon is a member of the Central African Economic and Monetary Community

    (Communaut Economique et Montaire de lAfrique Centrale CEMAC), which is

    composed of six member countries: Cameroon, Central African Republic, Chad,

    Republic of Congo, Equatorial Guinea and Gabon. The CEMAC is composed of the

    following four institutions:

    Central African Economic Union (Union Economique de lAfrique Centrale -

    UEAC)

    Central African Monetary Union ( Union Montaire de lAfrique Centrale -

    UMAC or CEMAC)

    Community Parliament

    CEMAC Court of Justice

    The UMAC/CEMAC, headquartered in Yaound, is responsible for the monetary policy

    of its member countries. It also works with the UEAC in the coordination of economic

    policies to ensure consistency between national budget policies and the common

    monetary policy. The UMAC is administered through:

    The Conference of Heads of States, created through the Agreement

    establishing the CEMAC, the supreme authority of the UMAC;

    The Council of Ministers;

    The Bank of Central African States (Banque des Etats de lAfrique Centrale, or

    BEAC), the common independent central bank;

    The Regional Banking Commission (Commission Bancaire de lAfrique

    Centrale, or COBAC), which harmonises and controls banking activities; and

    The stock market (Bourse des Valeurs Mobilires).

    Cameroons bank of issue is the BEAC, which replaced the Central Bank of the State

    of Equatorial Africa and Cameroon in November 1972. Its headquarters are in

    Yaound. In 1993, member states of the BEAC created a supranational supervisory

    authority (Commission Bancaire de l'Afrique Centrale) in order to secure the region's

    banking system. The government's Exchange Control Office controls all financial

    transactions effected between Cameroon and foreign territories. In 1999,

    Cameroon's banking system consisted of nine commercial banks with 60 branches.5

    In terms of Cameroons banking regulatory structure, the BEAC regulates the

    banking sector through the COBAC. COBAC has the authority to take disciplinary

    action. Both COBAC and the Cameroon Ministry of Finance and Budget must license

    banks, and there are special regulations for smallscale credit cooperatives.

    Cameroons financial sector includes 10 commercial banks, 11 nonbanking financial

    establishments, about 652 microfinance institutions and a growing number of

    5 Kouassi, Armel, Akpapuna, Jennifer and Soededje: Camerooon, at http://fic.wharton.upenn.edu/fic/africa/Cameroon%20Final.pdf

  • 92

    foreign exchange bureaus. The banks operate in the country within the regulatory

    framework of the COBAC which has established stringent prudential rules.6

    2.1 Civil Law in Cameroon

    Cameroons Civil Code includes statutes regulating the protection of contracting

    parties when forming and fulfilling obligations, particularly with respect to consent.

    Furthermore, the Cameroon legislature introduced provisions for protecting

    consumers in Law No. 90/031 of 10 August 1990, which regulates commercial

    activity in Cameroon (Title IV). This law is complemented by Implementing Decree

    No. 93/720/PM of 2 November 1993. However, while these regulations include a

    requirement to display prices and govern some sales practices, they focus on the

    sale of moveable tangible property and lack provisions on financial services.

    The Minister of Trade was asked to submit a draft bill about consumer protection to

    the Head of Government (Prime Ministers Office Meeting of 26 March 2009), but the

    Minister has still not completed this request as of this writing.

    2.2 Common Law and Customary Law

    One characteristic of Cameroons legal system is its pluralism, from both an

    institutional and a material point of view. The countrys judicial system includes both

    modern courts that apply written law and traditional legal courts that follow

    customary laws. We tried to discover if customary law has or could have some

    influence on microfinances procedures for settling disputes. Article 2 of the Decree7

    on the Organization of the Judicial System, as well as the procedure before

    traditional courts of Eastern Cameroon, explains:

    1. Traditional courts are competent to deal with cases only if all interested

    parties agree to it and if current rules do not reserve the matter to courts of

    modern law.

    2. If one or more interested parties are not agreeable, the case must be

    dealt with before a court of modern law.8

    In practice, only family issues are generally subject to customary law.

    Common Law is applied only in the countrys English-speaking northeastern and

    southeastern regions, or by express request of the contracting parties. In this report,

    for purposes of comparison, we have analysed contracts established under Common

    Law.

    2.3 International Law 1: OHADA Law

    Cameroon adheres to the general trade laws of the Organisation for the

    Harmonization of Business Law in Africa (Organisation pour l'Harmonisation en

    Afrique du Droit des Affaires, or OHADA). It is an 18-year-old system of business

    6 Ibid. 7 Decree N 69-DF-544 of 19 December 1969. 8 1. La comptence de ces juridictions est subordonne lacceptation de toutes les parties en cause. Nonobstant toutes dispositions contraires, la juridiction de droit moderne devient comptente dans le cas o lune des parties dcline la comptence dune juridiction de droit traditionnel. 2. Sous cette rserve, ces juridictions sont comptentes pour connatre des procdures civiles et commerciales que les textes en vigueur ne rservent pas aux juridictions de droit moderne.

  • 93

    laws and implementing institutions adopted by 16 West and Central African nations.

    OHADA law applies directly and supersedes national regulations per Article 10 of the

    Treaty on the Harmonization of Business Law in Africa.9

    At present, OHADA law includes only a few standards directly related to consumer

    rights. Two laws deserve mention in this report because they define the legal

    framework for some microfinance transactions. These two standards are the Uniform

    Act Organizing Simplified Recovery Procedures and Enforcement Measures and the

    Uniform Act Organizing Securities.

    A preliminary draft of The Uniform Act on Contract Law was written according to the

    principles of Institut international de lunification du droit priv (UNIDROIT), and

    transmitted to the Permanent Secretariat of OHADA in September 2004. This law

    would undoubtedly concern consumers of financial products, because it instead of

    the current Civil Code will regulate their conventional relationships with financial

    services suppliers. In particular, it will deal with the conditions of contract formation,

    and include public policy provisions that are protective of the parties, as well as any

    eventual grounds for contract nullification. Finally, in the event of non-payment by

    micro-entrepreneurs, this law defines the methods for eliminating obligations, which

    complement the regulatory procedures in the Uniform Act.

    OHADA announced a draft law about the issue of consumer sales. However, the

    concept of sale excludes activities of financial intermediation.

    2.4 International Law 2: CEMAC/UMAC/COBAC Law

    The law of CEMAC institutions has several provisions that indirectly concern

    consumer protection. Regulation n01/02/CEMAC/UMAC/COBAC on microfinance

    activity makes a particular reference to MFIs code of ethics.10 Article 65 of the same

    regulation further stipulates: The microfinance institutions should regularly publish

    their financial situation and display the relevant conditions to the client.11

    The Plan of Action for Strengthening Financial Intermediation in Cameroon (Plan

    dAction en vue du Renforcement de lIntermdiation Financire au Cameroun, or

    PARIF) conceived and drafted by senior officials of the Ministry of Finance

    according to recommendations made by the Evaluation Programme of the Financial

    Sector (Programme dEvaluation du Secteur Financier, or PESF), the International

    Monetary Fund (IMF) and the World Bank in June 2007 was validated during the

    February 2008 review in Yaound and revised in April 2008 in Washington, D.C.

    9 Article 10: The uniform acts are directly applicable and obligatory in contracting states, notwithstanding any contrary provisions of a previous or subsequent internal law. 10 Article 50: Tout tablissement est tenu de se doter dun systme de contrle interne susceptible de lui permettre de : Vrifier que ses oprations, son organisation et ses procdures internes sont conformes la rglementation en vigueur, aux normes et usages professionnels et dontologiques ainsi quaux orientations de lorgane excutif et dlibrant ; () . Any establishment is obliged to maintain an internal system of control that enables it to: verify that its operations, its organization and its international procedures are in line with the regulations in force, the standards and professional and deontological uses as well as the policies of the executive and decision-making branch of the government (). 11 les tablissements de microfinance doivent publier priodiquement leur situation financire et afficher les conditions applicables la clientele.

  • 94

    The PESF analysis revealed, in particular, the lack of transparency about the costs of

    credit, problems in contract enforcement, and the lack of reliable information on the

    quality of borrowers, among others.

    In this context, the Ministry of Finance in Cameroon has pledged that it would

    propose to COBAC the promulgation of new regulations that would require credit

    institutions in the sub-region to regularly publish their lending terms, in order to

    make credit operations transparent.

    PARIFs implementation is overseen by a Committee established by the Ministry of

    Finance and presided over by the General Director of the Treasury (Coopration

    Financire et Montaire and Monnaie et des Assurances) following Decision N. 869

    MINFI/CAB of 9 April 2008.

    In regards to the legal system, the Committee proposed various actions, notably:

    A draft bill modifying and complementing the Law of 19 April 2007 (creating

    the position of judge in charge of litigation). The bill sought to establish

    emergency court procedures with respect to the collection of collateral of

    borrowers who have defaulted on their loans.

    The Monetary Authoritys proposal relating to bankers, whose objective is to

    regulate arbitration clauses and the determination of costs.

    The Committee also produced a draft law on the creation of an MFI Deposit

    Guarantee Fund (Fond de garantie des dpts des EMF, or FOGAMIC) which, for the

    time being, only focuses on cooperatives. As prescribed by COBAC, it seeks to

    reimburse members in the event that their deposits are lost.

    In our view, a quick review of the entire regulatory framework on consumer

    protection demonstrates, on the one hand, the dispersed nature of regulations, and

    on the other, their inadequacy. Despite the relevance of the subject, the Cameroon

    legislature has never addressed the specific issue of protecting consumers of

    microfinance services.

    Nonetheless, if the laws described above were implemented, they would cover most

    of the issues relating to consumer protection. However, Cameroon would still need to

    improve its institutional framework to support the effective implementation of these

    laws.

    Some national and regional institutions could establish protection for consumers of

    financial services and products, but none of them has yet taken on this role, and it

    would require enabling legislation for them to be able to do so. In addition,

    Cameroon has consumer protection associations, but these groups have not yet

    included financial services in their mandate.

    2.5 The Directorate of Consumer Protection

    Decree n2005/089 of 29 March 2005 of the Organization of the Ministry of Trade

    established the Directorate of Consumer Protection within the Ministry. This

    Directorate is, in particular, responsible for drafting and implementing legislation and

    regulations on prices, consumer protection, collection, and the processing and

    dissemination of price-related information, among other matters.

  • 95

    More specifically, the Sous-direction des Etudes et de la Lgislation (Sub-Directorate

    for Research and Legislation) is responsible for, inter alia, international cooperation

    with regard to prices, consumer protection, metrology and collection. The Cellule de

    la Normalisation et de la Protection du Consommateur (Standardization and

    Consumer Protection Unit) is responsible for collecting, processing and disseminating

    information on consumer protection, the monitoring of national and international

    consumer protection organizations, and identifying and classifying consumer

    organizations.12

    2.6 Bank of Central African States (BEAC)

    At the regional level, a National Credit Council (Conseil National du Crdit, or CNC) is

    established in each Member State, at the National Directorate of BEAC. CNC, which is

    presided over by the Minister of Finance, includes representatives of BEAC and

    primary banks. Its mission is to examine and monitor bank operations and the

    distribution of credit within the national economy and to monitor if the financial

    system as a whole (primary banks and financial institutions) complies with the bank

    standards and conditions defined by NCC.

    Some public or private institutions, therefore, have the mandate to uphold consumer

    rights. Unfortunately, there are no institutions responsible for verifying that the

    existing laws are applied, or for providing educational, legal and institutional support

    to MFI clients.

    The imbalance of trade relations between consumers and providers of credit is still

    rooted in the fact that consumers are dispersed and unable to provide a united

    common front. In our view, consumers will be able to promote their claims and their

    interests only when one or several national institutions are established to gather and

    process all of their grievances.

    Accordingly, the second half of this article measures the gaps between Cameroons

    laws and microfinance practice to identify concrete steps that may improve client

    relations.

    3. Field Research

    In a one-year research project in Cameroon, we conducted an analysis of primary

    sources: bills and decrees and over 50 contracts. We also conducted more than 100

    in-depth interviews with clients of microfinance institutions (MFIs), along with

    approximately 30 directors and employees of large MFIs, and several judges in

    Cameroon.

    The first legal principle governing the relations between financial institutions and

    their clients is that of contractual freedom, but in our research we found that the

    relationship between the consumer and MFIs is clearly imbalanced. Clients are often

    not familiar with their rights and do not necessarily understand the financial products

    that they are buying. Therefore, Cameroons first consumer law governs the

    expression of consent. Consumers are not completely helpless, and consumer

    protection laws can inform their decisions by dictating procedures for how the

    agreements are reached.

    12 Decree n2005/089 of 29 March 2005 on the Organization of the Ministry of Commerce Articles 40 and 48.

  • 96

    Yet, with respect to consumer protection, Cameroons laws are nonetheless both

    incomplete and not well applied, since they do not completely address the

    contractual act. Further, clients often do not know their rights either because they do

    not read their contracts or the financial institution does not provide them with copies.

    Clients also often fail to request explanations of their rights by the MFIs

    representatives before signing the loan contract.

    3.1 Informational Asymmetries

    We first sought to ascertain if there are informational asymmetries between MFIs

    and their clients which make it difficult for consumers to make effective decisions.

    Our research was based on a small sample of clients of MFIs in categories 1, 2 and

    3,13 mainly in urban areas (Yaound and Douala). We began by examining the

    subjective competence of consumers by asking them to estimate their own capacity

    to understand the contracts. We then tried to objectively assess this level of

    competence by asking them about the details of the contracts they have signed.

    Figure 1. Was the information that you first received

    exact, incomplete or unclear, or false?

    In our research, we found that the clients we interviewed were generally satisfied

    with the information available when they selected their financial services. 75 percent

    of the borrowers we interviewed said that they considered the information they

    received from their MFIs to be complete and exact; only 25 percent considered the

    13 Explanation of MFI categories: Category one are cooperative institutions, which provide savings opportunities exclusively to members and then use these savings to offer credit for member-run projects. These organizations cannot seek profit and exist for the sole purpose of empowering their members. Category two microfinance institutions are profit-seeking institutions that offer savings and credit services to the public. Category three microfinance institutions are profit-seeking institutions which provide credit services to the public, but do not offer savings services.

    75%

    25%

    0%

    Exact Incomplete or Unclear False

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    information to be exact, but incomplete. None of the people we interviewed felt that

    they had been cheated.

    Figure 2. Have you clearly understood the terms of the contract?

    On the other hand, this perception was substantially at odds with an objective

    assessment of the clients understanding of the contracts. Most of the clients

    interviewed did not understand the credit terms they received. A large percentage of

    the clients could barely understand their interest rate terms.

    Indeed, the MFIs that we surveyed explained that most clients wish to obtain credit

    at all costs. As a result, they often accept the conditions offered them without

    dispute. Further, interest rates on loans are freely set by each MFI.

    3.2 Advertising, Price Display and Sales Practices

    In Cameroons microfinance sector, advertisement does not seem to be the primary

    form of marketing communication. Some large MFIs use posters or brochures, but

    most stated that they primarily rely on customers recommending their services to

    other people, or active canvassing.

    70%

    15%

    15%

    Yes No Not completely

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    Figure 3. How did you hear about MFI services for the first time?

    The Cameroonian legislature has passed laws to regulate the reliability of information

    that clients receive. Accordingly, Law 199014 prohibits misleading advertising.

    Cameroon jurisprudence strengthens this obligation, making it mandatory to observe

    the advertised price.15

    To this prohibition on providing misleading information, the Law of 1990 also adds

    the obligation to inform, which provides consumers with information and guides

    them in their consent. The law states, in relevant part:

    Article 20: Any seller or service provider must inform the consumer

    [of] the price, by marking, labelling or any other appropriate

    meansThe specific methods of advertising prices, [and] the

    essential characteristics and conditions of sale of some products or

    services could be determined by law.16

    With respect to financial services, this Article on particular methods of advertising

    was not enforced for a period of 20 years, or until 2009. That year, the Ministry of

    the Economy and Finance published detailed regulations regarding price displays in

    MFIs.

    The information received by the client on the conditions of his credit is often

    presented in the form of a repayment schedule. Cameroons regulations make it

    mandatory for banks (and only banks) to communicate this document. Almost all of

    14 Law 90/031 of 10 August 1990 specifying the conditions relating to the carrying on of commercial activity in Cameroon, Article 22. 15 TPI of Douala, 13 Dec. 1994. 16 Article 20 : Tout vendeur ou tout prestataire de service doit, par voie de marquage, d'tiquetage ou par tout autre moyen appropri informer le consommateur sur le prix. Les modalits particulires de publicit des prix, des caractristiques essentielles et des conditions de vente de certains produits ou services pourront tre dtermines par voie rglementaire.

    0%

    36%

    34%

    30%

    Advertising Friends Door-to-door Others

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    the MFIs we interviewed systematically use a repayment schedule or a simulation

    table as a pedagogical tool to present sale conditions. The simulation table shows the

    amount borrowed, the monthly payments and the interest rate.

    However, it is difficult to compare interest rates offered by different organizations in

    Cameroons microcredit market. We in fact made an inventory of the numerous ways

    at least five by which deposit interest rates were posted. Some show a

    percentage of the total amount borrowed; others, a monthly rate; others still, an

    annual rate. Finally, some only provide a nominal amount, not even taking the time

    to express it as a percentage.

    The idea of stipulating one method for calculating interest rates has already been

    proposed, but the subject is controversial. On 22 July 2010, a sub-regional

    conference was organized in Douala by BEAC on the topic, establishing an APR

    (Annual Percentage Rate or TEG, Taux Effectif Global) and a usury rate in CEMAC in

    banking and microfinance. However, the MFIs prepared a memorandum addressed to

    the Ministry of Finance that listed several reasons why they should be exempted

    from such measures, including the sectors extremely high operating, collection and

    recovery fees, and relatively small profit margins.

    In our view, the key to this debate is to avoid dealing with the issue of APR and that

    of the usury rate at the same time. While the usury rate has a strong risk of

    handicapping a sector with low-profit margins (as in Mauritania or Benin), a standard

    method of interest-rate calculation could help in increasing competition and

    establishing a market rate.

    We tried to evaluate overall customer interest pursuant to a uniform interest rate

    calculation methodology, but we discovered that awareness about the usefulness of

    annual percentage rates was quite low among the clients we interviewed. For

    example, some people seemed to find annual percentage rates more confusing than

    referring to nominal amounts. This awareness problem will have to be considered

    when establishing a policy for calculating interest rates.

    Inadequate legal provisions do not explain the variances in the microeconomic

    behaviour of clients. Indeed, even when clients have information on prices, their

    choices can often be influenced by other considerations. We therefore tried to

    understand the process by which a client chooses an MFI. In the urban areas where

    we conducted almost all of our research, the MFIs are highly competitive. The MFIs

    are widespread in Douala, Bamenda and Yaound, and one is always within walking

    distance of an agency.

    Most of the clients we interviewed selected MFIs that had contacted them. Almost

    half were canvassed by an employee, particularly the daily collectors of urban

    cooperatives. The members or clients often turn to their regular institution to seek

    credit. Almost none of the clients we interviewed chose his or her MFI according to

    research on credit or savings terms. Our interviews revealed that bankruptcies and

    frauds in the microfinance sector in recent years have led clients to lose trust in

    microfinance institutions. As a result, many of the interviewees selected institutions

    where they know an employee, a family member, a neighbour or a friend, or those

    that are owners of their building meaning institutions that they consider to be

    serious.

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    To verify the conditions of consent, the parties are also required to comply with the

    regulation relating to selling practices, provided for in Article 25 of the Law of 1990:

    It is prohibited to make the sale of a product conditional upon the

    purchase of another product or of another service[,] as well as to

    make conditional the provision of a service on that of another service

    or the purchase of a product.17

    In the case of financial services, such a provision could, for example, concern forced

    savings, a condition sometimes imposed at the time a microcredit contract is signed.

    Forced savings requires a microfinance borrower to put aside funds to enforce loan

    repayment; it does not refer to deposits in the conventional sense. It is difficult

    from this perspective to judge the practice of blocked savings, which is widespread in

    the microfinance sector throughout the world. This practice is particularly popular

    with cooperatives as a form of guarantee.

    Installing a cooling-off period could be a supplementary step, as introducing a time

    condition to the contract creates a healthy period of reflection for the borrower.

    While Cameroonian law does introduce a cooling-off period, it is applicable only in

    case of door-to-door selling. In Cameroonian law, the place where the contract is

    signed the clients home or the MFIs branch - is a key indicator of the consumers

    consent

    The issue regarding the characterization of the work of daily collectors is often

    raised. Indeed, these young women, employed by the cooperatives, perform tasks

    that could clearly be referred to as canvassing, because they meet clients on the

    street or at their place of work. If jurisprudence eventually qualifies it as such, those

    transactions in the marketplace might be subject to the withdrawal power. In

    practice, collectors transactions are numerous, small in volume, and are supported

    by very few written documents or records the clients savings books which

    make them difficult to regulate.

    3.3 The Formal Requirements of Financial Contracts

    Regulating the form of contracts is another way to ensure the honesty of

    agreements. Having noted the reality of adhesion contracts in commercial practice,

    the legislature deemed it useful to draw the consumers attention to certain

    contractual and Civil Code provisions that they may otherwise ignore.

    Firstly, requiring a written contract for credit and savings transactions constitutes a

    significant consumer protection mechanism. The written form provides some

    measure of solemnity at the moment of signature, as well as evidentiary proof in

    case of litigation. In Cameroon, the written form is therefore required for all amounts

    over CFAF 500 (Art. 1341, 1342, 1344 of the Civil Code).

    Moreover, OHADA law provides for the form of security: with pledges as the sole

    exception, all liens on property must be in written form. The guarantee must be

    declared in an act undersigned by both parties, which has the handwritten statement

    17 Il est interdit de subordonner la vente d'un produit l'achat concomitant d'un autre produit ou d'un autre service ainsi que de subordonner la prestation d'un service celle d'un autre service ou l'achat d'un produit.

  • 101

    declaring the collateral and the maximum guarantee amount written in letters and

    figures.18

    In contrast, Cameroonian law does not include regulations that require an obligatory

    statement in credit agreements, setting forth the rights and duties of consumers or

    of the guarantee. Such compulsory statements are provided for, as an example,

    under Article 819 of the Confrence Interafricaine des Marchs d'Assurances Code

    (Code of the Inter-African Conference on Insurance Markets) for insurance products.

    The written form of financial services contracts is generally respected by the MFIs we

    interviewed, but not systematically so. We asked many clients if they had received a

    copy of their contracts. Most responded that they had read their contract and

    received explanations, but only 34 percent stated that they had been given a copy

    thereof. A certain number of them received, in lieu of the contract, an amortization

    table, with the statement read and approve.

    Figure 4. Did you read the contract before signing it?

    18 See Article 4 (2) Uniform Act Organizing Securities of the Organization for Harmonization of Business Law in Africa (OHADA). 19 See http://gaboneco.com/Docs/CIMA_Code_assurances.pdf.

    48%

    48%

    4%

    Yes No Others

    http://gaboneco.com/Docs/CIMA_Code_assurances.pdf

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    Figure 5. Was the contract explained to you?

    Figure 6. Did you receive a copy of the contract?

    Several MFIs in Cameroon provided examples of the contracts they use. As a result,

    we collected 57 sample contracts from nine of the countrys prominent institutions.

    These contracts cover all the possible legal relations between debtors, MFIs and

    guarantors, including all types of security interests cited in this publication.

    There is insufficient space in this report to present a detailed review of these

    documents, but several preliminary remarks can be made. While it is clear that the

    organizations attempted to use simple language, the legal language used in several

    clauses in the contracts is still difficult to understand, even for lawyers.

    72%

    12%

    16%

    Yes No Other

    61%

    34%

    5%

    Yes No Other

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    Moreover, in many of the documents, it is difficult for customers to calculate the cost

    of credit at one glance. One example is when a contract refers to general sales

    conditions such as costs or penalties that are in a separate document. This is

    also the case when the interest rate is indexed to the refinancing rate of the Bank of

    Central African States (BEAC).

    The MFI agents and directors often attribute misunderstandings with their clients to

    bad faith. In our view, although this is difficult to measure, it is indeed very likely

    that clients are as careless about terms and conditions when signing the contracts,

    as they are serious about sales practices once the credit expiration date comes. In

    this regard, it is likely that new strategies concerning information for clients, as well

    as the establishment of cooling-off periods, could screen out uninformed clients prior

    to litigation. The relevance of these options would need to be assessed from a

    commercial point of view.

    3.4 The Notion of Public Order

    With the emergence of the theory of adhesion contracts, seeking consent free

    from any defects undoubtedly leaves room for an agreement free from all defects.20

    Beyond verifying consent, the Cameroon legislature will intervene, in a positive or

    negative manner, in order to limit the contents of the contracts. This concerns the

    classic notion of public order in civil law: the compulsory rules which the co-signers

    may not deviate from by agreement.

    Since 1990, Cameroon law has incorporated a public order dimension in contractual

    undertakings, as follows:

    Article 27: Clauses of agreed contracts between professionals and

    consumers shall be deemed as not written when they are in fact

    imposed on the consumers and confer an excessive advantage to

    professionals, allowing them to withdraw in part or in full from their

    legal or contractual obligations. 21

    Two comments can be made. First, the provisions infringing on public order are

    simply deemed unwritten. They are not grounds for cancelling a contract. Second,

    the Law of 1990 gives the judge the sole power of discretion in the domain of public

    order, under vague terms of excessive advantage.

    The contracts that we observed sometimes contain illegal clauses, or clauses that are

    unclear, particularly concerning the establishment of security interests or the rights

    of the parties under the Civil Code. These clauses, although null from a legal point of

    view, mislead consumers with regard to the true extent of his or her rights. This is

    the case, for example, when a clause states the right of an MFI to directly claim a

    valuable asset, without it being clear to the debtor if this claim must be made in

    court before a judge.

    20 La protection du consommateur en droit camerounais. Tedondjio Rocisse Hilaire, 2004 21 Law n 90/031 of 10 August 1990. Article 27 : Sont rputes non crites les clauses des contrats conclus entre professionnels et consommateurs qui sont en fait imposes aux consommateurs et confrent un avantage excessif aux professionnels en leur permettant de se soustraire pour partie ou en totalit leurs obligations lgales ou contractuelles.

  • 104

    This is also the case when a clause indicates that the debt shall be transferred to

    eventual successors (e.g., [t]he debt of this contract could be claimed from the

    borrowers inheritors) without specifying that the Civil Code of Cameroon, under

    Article 775, clearly provides for the possibility of waiving the liability (or asset) of an

    inheritance following an inventory.

    3.5 Interest Rate and Usury

    The public order provision for consumer protection that immediately comes to mind

    is that relating to price regulation. The international media has repeatedly drawn the

    publics attention to interest rates charged in the microfinance sector. We have tried

    to answer the following questions: What are the interest rates applied by MFIs in

    Cameroon? Are these interest rates abusive? Do these interest rates lead to effective

    competition in the microcredit market? Finally, should microfinance rates be

    regulated? If so, how?

    3.5.1. Observed Interest Rates

    In December 2009, a non-governmental organization (NGO) from Cameroon (ADEM,

    based in Yaound), published a report about interest rates charged on loans made by

    MFIs in Cameroon. This NGO carried out a review of interest rates charged by about

    100 MFIs, and since then, has been dedicated to denouncing excessive rates

    observed. The annual percentage rates reported by the NGO were generally very

    high - an average of 42 percent, and as high as 78 percent.22

    Our research did not completely confirm these figures. About half of the clients we

    interviewed were able to provide us the monthly, annual or total tax rate that was

    invoiced (56 clients in total). Using the assumption that credit was extended for a

    duration of 12 months (which frequently seems to be the case),23 and the hypothesis

    that the announced monthly rates are calculated using the decreasing balance

    method (which most often seems to be the case, based on contracts obtained), we

    estimated an annual average rate of 21.9 percent. Admittedly, this result does not

    account for possible forced savings and fees. Even with those costs, the average was

    still less than 30 percent per year.

    However, the rate we observed does not exactly represent the market. Indeed,

    although the rate is higher for merchants (between 2 and 4 percent per month, on

    average), we interviewed many more salaried workers whose rates were generally

    somewhat lower (rarely beyond 1.5 percent per month).

    3.5.2. A Market Interest Rate?

    In order to preserve contractual balance, legislators are sometimes tempted to turn

    to price regulation - in this case, setting a usury rate.

    In Cameroon, the deposit rate is regulated.24 But since 2008, there has been no legal

    limit for lending rates. 25 As the MFIs regularly emphasized, a usury rate is a blind

    22 ADEM, Taux dintrt dbiteurs usuraires en microfinance au Cameroun, November 2009. 23 This figure was used for credits whose duration we do not know. 24 Article 53 of Ordonnance n. 85/002 of 31 August 1985 on the practice of credit instiutitons. Articles 7, 14, 15, 19, 20, 21, 22 and 28 of Arrte n244/MINFI/DCE of 5 August 1989 on the conditions of bank modified by Arrte n00001/MINFI/CSB/REP of 4 January1995. 25 Decision N05/CPM/2008 of the BEAC Monetary Policy Committee.

  • 105

    tool. It does not take into account the fact that, for small credit, the set fees are

    proportionally higher and the margins lower.

    On the other hand, it is important to recognize that price competition, which should

    be established on prices, does not really occur. Microcredit in Cameroon has not yet

    established a market rate per se. This will only occur when the methods for

    calculating interest rates are harmonized.

    3.6 Array of Security Interests in Cameroonian Microfinance

    We tried to verify the legality of the security interests used, and focused in particular

    on the formal requirements of registration. We also sought to verify the adequacy of

    these security interests with respect to the amount of credit committed.

    Contrary to popular belief, the great majority of credit granted by Cameroon MFIs is

    backed by security or collateral. Often, the clients even cite an accumulation of

    security - for example, a guarantee and a mortgage.

    The MFIs do not use all forms of security provided by the OHADA Uniform Act

    Organizing Securities; on the contrary, they sometimes create new ones.

    3.6.1. Security Interests: Authentic Pledges and False Mortgages

    MFIs use all forms of security provided for by the Uniform Act Organizing Securities:

    non-possessory collateral, possessory collateral (pledges) and mortgages.

    Figure 7. What type of security interest was used?

    Collateral that is, the non-possessory charging of an asset seems adapted to

    most microcredit institutions. The collateral observed concerns professional

    equipment, commercial stock, furniture, appliances and vehicles.

    44%

    29%

    27%

    Personal guarantee Mortgage Pledge

  • 106

    The pledge, however, involves a dispossession, which excludes a priori the factors of

    production and stock. As a result, we observed pledges on objects of classic value:

    e.g., motor vehicles or chain saws. A few MFI officials stated that they have

    warehouses to store pledges, but admitted that it is extremely complicated to

    manage the warehouses and settle disputes that arise about the deterioration or

    degradation of the pledged assets.

    In reality, when MFIs speak of pledges, they often mean the withholding of original

    documents (e.g., car registration papers) while leaving the possession of the object

    with the owner, or a mere non-possessory collateral.

    One point we tried to understand is why many clients spoke of mortgages, or

    pledges of property titles for operations, that seemingly were not registered.

    The interviewees mentioned mortgages for the land title of my house, the

    documents of my stall at the market, the documents of my house, the papers of

    my house, the title property of my house and land certification in the western

    area of Cameroon. The underlying practices reflected in these descriptions represent

    an innovation found only in Cameroon: the pledge of assets of cultural value, and of

    legal acts.26 From the accounts we collected, it seems that such pledges are confused

    with real mortgage by clients or even by the MFIs themselves.

    This practice provides no guarantee for the MFI because the client can easily obtain

    duplicates or a certificate of loss of his ownership title, and sell the property or give it

    in guarantee to another MFI elsewhere. Several MFIs have been victim of this

    deception. The non-formalization of guarantees is a high risk for the MFI.

    3.6.2. Personal Security

    Personal security also seems indispensable to the development of microfinance in the

    country, e.g., guarantees, as well as loan guarantees from acquaintances, colleagues

    and friends. An interesting confusion was observed among several cooperative

    members: the itinerant canvasser or daily collector allegedly guaranteed for them.

    This, however, seems highly unlikely. At best, they benefited only from a moral

    guarantee with respect to the MFI.

    One remark needs to be made. The interviews we conducted demonstrated the

    general practice of associating personal guarantees with collateral - that is, the

    allocation of a guarantors asset, such as, notably, a mortgage guarantee.

    3.6.3. Other Forms of Security

    Salary domiciliation: Sometimes called the irrevocable certificate transfer of

    salary, or the irrevocable certificate of salary transfer; similarly, domiciliation

    of rent or delegation of rent.

    The deposit check: A check deposited by the borrower with the MFI, but not

    encashed. However, the practice of deposit checks is now prohibited in

    Cameroon. Before this ban, it was common to accept a blank check, signed by

    the debtor or his guarantor. In the event of a debit balance, an amount was

    written on the check that was then presented for encashment. Since there

    26 PETIPE Patern Aim, La garantie des creances des COOPEC: le cas du reseau CamCCUL, Mmoire de D.E.S.S., Universit de Yaound II, January 2008.

  • 107

    were no funds, it would then be marked as non-sufficient funds (NSF), which

    would lead to legal proceedings against the borrower who wrote the check.

    Today, legal proceedings could be undertaken for the beneficiary and against

    issuer if it is established that the check was issued to guarantee a debt, i.e.,

    at the time of the issuance, both parties knew that the account did not have

    funds. In principle, all checks issued must be dated and encashed within eight

    days. Although they can no longer undertake legal proceedings against the

    issuing party, MFIs are still taking this risk, possibly because many clients

    ignore the legal provisions.

    An irrevocable sell order in the presence of a notary.

    The delegation of power (power of attorney): This security grants the MFI,

    through its president, the power to sell the property for payment of a debt. It

    is sometimes accompanied by another agreement such as an obligation to

    register the property. This way, some MFIs will replace a proper mortgage

    arrangement with a series of three to four contracts, which authorizes them,

    if the creditor defaults, to register a property, sign a mortgage and then take

    ownership. These contracts are a fragile legal construct. They are rarely

    enforced, but are destined to intimidate the customer.

    Trust: The debtor transfers the title of his immoveable asset to his creditor

    until the debt is repaid. The trust, as reassuring as it can be for the creditor,

    is not yet classified by OHADA law as a legitimate security.

    Promissory note: A third party signs a promissory note that the MFI could use

    against the borrower in case of default on the principal debt. This second

    debt is a kind of autonomous guarantee, completely disassociated from the

    principal debt. The MFI could, in theory, resort to this second debt without

    having to prove non-payment of the initial debt.

    3.6.4. Registration and Inscription

    In order to allow the enforcement of collateral and mortgages, the OHADA laws

    provide both for their registration and their inscription. Registration is conducted at a

    competent tax centre. Inscription is performed at an ad hoc administration: Registre

    du Commerce et du Crdit Mobilier (Trade and Real Estate Credit Register, or RCCM),

    Bureau des Domaines et de la Conservation Foncire (Office of Domains and Land

    Conservation), Registre de la Proprit Intellectuelle (Register of Intellectual

    Property), and Bureau des Transports (Office of Transportation).27

    We asked the MFIs if they regularly registered their collateral. We received the

    following answers:

    27 Ibid.

  • 108

    Figure 8. What type of security did you use?

    The MFIs explained their reluctance to register security interests due to cost, lack of

    matriculation of buildings entitling them to the issuance of the property title, and the

    building registration fee.

    The MFIs deplore the fact that land is rarely registered. Indeed, the percentage of

    registered lands in Cameroon is estimated at 15 percent - at least 10 percent in

    urban centres, and 2 percent in the rural and semi-urban areas.28

    A second complaint about the OHADA Uniform Act is the disproportional cost of

    formal requirements. Yet, the cost of formal requirements associated with the

    publication of security interest is borne by the client, who contributes to the credit

    cost. Moreover, since 8 April 2008, collateral and mortgages for MFIs transactions

    are registered free of charge.29 Unfortunately, this law is not widely enforced, so

    many MFIs choose to ignore its provisions. Also, collateral is still subject to an

    inscription tax of 1 percent of the value of the credit, including interest. Taking into

    account the ratio observed between the value of security interest and the debt (see

    below), we estimated that the registration fees range between 3 and 4 percent of the

    credit amount.

    Finally, with respect to mortgages, borrowers are also charged, along with the

    registration fees, the costs of obtaining certificates of non-mortgage, or certificates

    of ownership, the notary costs and possibly expert fees to evaluate property values.

    Besides, the loans granted by the MFIs are generally short-term, while the time

    needed to carry out these formal requirements is often long (on average, three

    months). Frequently, the credit will be paid back even before the formal

    requirements of registration are completed.

    28 Ibid. 29 Circular N125/MINFI/DGI/LC/L of 9 April 2008.

    54% 30%

    16%

    Securities always registered Securities rarely registered Securities never registered

  • 109

    3.6.5. Over-collateralisation

    Another topic of interest was the issue of disproportionate security interests. We

    asked clients about the price of the security, on the one hand, and the amount of

    their credit or loan, on the other. Twenty-one individuals answered with adequate

    precision, making it possible to draw a comparison. The graph shows in ascending

    order the ratio between security interests and debt.

    Figure 9. Loan : Credit Ratio

    The average ratio of security to debt is 3.56 this means that the value of security

    requested is, on average, 3.5 times higher than the established debts. Only one

    value was below 1 (red line), meaning that we found only one instance of an MFI

    accepting a security of lesser value vis--vis the debt.

    3.7 Redress Mechanisms

    The malfunctioning of redress mechanisms can be harmful for two reasons. On the

    one hand, it can impact the quality of the MFIs portfolio, particularly its ability to

    protect itself from borrowers of bad faith. On the other hand, borrowers themselves

    are too often subject to illegal and intrusive recovery procedures.30

    It is difficult to assess the proportion of disagreements associated with microfinance

    services that are finally resolved through the Cameroon courts, but it seems to be

    30 Laurent Lhriau, La microfinance commerciale en zone urbaine : quelles possibilits et quelles perspectives en zone franc? Epargne sans Frontires, Techniques financires et dveloppement, n68, September 2002.

  • 110

    the exception. Without doubt, the cost, slowness, and, to a certain extent, the

    uncertainty of its outcome, explain the weak attractiveness of judicial conflict

    resolution.

    Although it may seem counter-intuitive, the weakness of redress mechanisms and

    debt-collection tools eventually results in customer inconvenience, as the MFI is

    forced to protect its portfolio with heavier collateral, higher costs, or sometimes

    harmful procedures.

    3.7.1 The Low Frequency of Cases

    The judges we interviewed indicated that they knew only of a few cases in which

    MFIs filed lawsuits against their clients. Indeed, the MFIs we interviewed seemed to

    confirm this point. Among eleven MFI directors interviewed, six stated that they

    never resorted to bringing legal actions, and three stated that they have been

    involved in litigation but that it was uncommon. Clients and institutions that we

    interviewed seemed to prefer out-of-court, or non-legal solutions.

    In almost all the cases described, the MFI was the complainant, and the cases

    concerned payment defaults on loans. The judges we interviewed could recall only a

    few rare cases that concerned consumer complaints against abusive recovery

    practices.

    In our research, we also found that is very rare for grievances to be of a criminal

    nature. This can only occur if the client engages in fraud, or even if the client is a

    victim of fraud. Rather, the MFIs grievances are most often judged under Article

    1147 of the Civil Code (contractual responsibility) and sometimes and this is good

    news under the Law of 1990 on consumer protection.

    3.7.2. Elements of Proceedings

    Considering information collected in other countries, we have focused in particular on

    the transparency and fairness of legal procedures related to MFI clients in Cameroon.

    In particular, we were interested in the issues of legal aid, judgment by default and

    the production of proof.

    The legal aid mechanism (i.e., when legal fees are paid for by the State) was

    reformed by Law No. 2009/004 of 14 April 2009, on the Organization of Legal

    Assistance, which widened the field of application of legal assistance. MFI low-income

    clients, natural persons, and an innovation since 2009 moral persons, can also

    benefit from compensation for legal fees.

    The second concern was the procedure with respect to judging a client in absentia or

    by default. This is a vital criterion in assessing access to justice in a geographical

    area. It actually gives an indication of the density of the legal map, on the one hand,

    and a measure of the right to be heard, on the other. And yet, according to the

    judges interviewed, the right to be heard does not pose a problem in 90 percent of

    the cases. In rare instances where the debtor is absent from court, the judge always

    ensures that he was present in the first hearing. In default of the above, the case is

    postponed.

    The third concern we examined relates to the capacity of MFI clients to obtain and

    save proof of their financial transactions. The judges, as well as the directors of the

  • 111

    MFIs, confirmed that the issue of proof has never been a particular problem for any

    party; the clients generally properly store their account books, deposit receipts,

    copies of checks and other vouchers.

    The main concerns that we had over the fairness of trials have proven to be

    unfounded. On the other hand, our research highlighted the courts limited budgets.

    In principle, the payment procedure should allow the creditor to recover his debt

    within a few months;31 however, the MFIs we interviewed mentioned procedures that

    are not only excessively long, but also unpredictable. They mentioned durations of

    up to six years. Added to this excessive timeline is the clearly disproportionate cost

    with respect to the amount of microcredits at stake. As the MFIs explained in the

    interviews, the cost can be as high as 50 percent of the claimed amount.

    3.7.3. The Outcome of Legal Procedures

    As a result, the forced execution of contracts is expensive and inefficient. The MFIs

    are rather pessimistic about the effectiveness of legal procedures. Half of the MFIs

    interviewed which had litigated disputes in Cameroonian courts admitted having lost

    their case, or having won but without being able to recover their debt, due to lack of

    assets to seize. Only two stated having always won or almost always winning their

    cases.

    Furthermore, it is the losing party that assumes the costs of the entire procedure. As

    such, whether the MFI loses or wins against an insolvent client, it nevertheless risks

    getting involved in a process that would only add huge costs to the loss of its loan.

    It is difficult to verify the MFIs negative perception. According to half of the judges

    we interviewed, it is the MFI that generally wins, particularly due to better

    management of cases and proof presented. However, it would be necessary to

    request statistics at the court registry to properly draw a conclusion.

    3.7.4. The Unsuitability of the Formal Justice Machinery in Microfinance Operations

    We have examined some aspects of the legal system to determine if there are

    possible harmful imbalances for MFI clients. In actuality, the opposite is true:

    Cameroons legal system seems to provide an expensive, protracted and inefficient

    solution to the settlement of claims, which is rather unfavourable to MFIs. Justice,

    being costly and overly delayed, proves to be unsuitable for the transactions of the

    microfinance economy. The contracts, largely deprived of legal strength, lose their

    significance.

    Consequently, the consumer is indirectly, yet undoubtedly, the biggest loser in this

    equation. Indeed, the same way that an inadequate provision of security deprives

    him of credit or obliges him to provide excessive and illegal guarantees, the lack of a

    system for enforcing obligations shifts the balance of power towards intrusive, illegal

    and costly mechanisms.

    31 PETIPE Patern Aim, La garantie des creances des COOPEC: le cas du reseau CamCCUL, supra note 26.

  • 112

    4. Conclusion: Recommendations for Strengthening Consumer Protection

    The following are key recommendations for strengthening consumer protection in

    microfinance lending in Cameroon:

    Harmonize the calculation of interest on credit, through a technical expert

    group (TEG).

    Ensure MFIs comply with the obligation to post bank conditions. Propose a

    single grid model for posting and publicizing these conditions.

    Launch discussions on the timeline for withdrawal within the framework of

    certain commercial practices, particularly canvassing.

    Open discussions on the imposed periods for reflection for the taking of

    guarantees.

    Annually organize a group to reread MFI contracts, in order to warn the public

    about illegal clauses and poorly written drafts.

    Make compulsory the provision of an original copy of the contract to each

    party.

    Implement controls on unconventional means by which guarantees are taken

    by MFIs.

    Create a think tank that will formulate a reform agenda with respect to the

    OHADA Uniform Act for Organizing Securities, and begin international debate

    on the subject with other stakeholders of the microfinance sector.

    Study alternative systems of dispute settlement specific to microfinance

    transactions.

    Develop new ways of training and creating public awareness.

    In general, to establish a comprehensive consumer protection regulatory framework

    for financial services, Cameroon may also consider the following recommendations:

    Prohibiting reckless lending (similar to the provisions in South Africas

    National Credit Act (NCA)). The South African Act protects consumers

    from reckless lending, and provides them with an understandable credit

    agreement in plain language and several other consumer protections.

    Requiring financial services firms to explain clearly to potential borrowers

    the key features (including any fees, commissions or other charges) of

    products and services.

    Ensuring clear, fair and full disclosure of interest rates and charges (e.g.,

    APRs or total cost of credit).

    Ensuring that debt recovery expenses charged to the consumer, if any,

    are reasonable.

    Requiring that any advice given by a financial services entity to a

    consumer be suitable for the consumer and take into account his or her

    circumstances.

    Prohibiting conditional sales. A conditional sale is an arrangement in which

    a buyer takes possession of an item, but the title remains with the seller

    until some condition is met, such as payment of the full purchase price.

    Instituting a cooling off period for certain loans, e.g., loans above a certain

    value and for a duration greater than a specified period of time.

    Requiring that financial firms periodically issue financial statements to

    consumers at stated intervals.

    Requiring that notifications be sent to consumers when an institution

    makes changes in the terms and conditions of financial products.

    Requiring proper training, professional standards and supervision of

  • 113

    relevant staff of financial entities or their agents.

    Requiring that financial entities treat consumers fairly, and enacting

    prohibitions on unfair, deceptive or aggressive practices.

  • 114

    References

    ADEM, Taux dintrt dbiteurs

    usuraires en microfinance au

    Cameroun, novembre 2009

    ATANGANA-MALONGUE Marie-Thrse,

    Le cautionnement rel dans l'acte

    uniforme OHADA n 872, p. 277,

    Edition Juris Africa, Paris

    HAMOA Hamidou, Le principe de

    lautonomie de la volont des contrats

    lpreuve des contrats de

    consommation, Mmoire de DEA de

    Droit priv fondamental, Universit de

    Douala, 2004

    KANTE Alassane, Rflexions sur le

    droit de la concurrence et la protection

    des consommateurs dans l'UEMOA :

    l'exemple du Sngal, Penant, Edition

    Juris Africa, Paris

    LONG Ian, Perceptions of Microfinance

    in Cameroon: A Case Study of UNICS,

    Yaound, SIT Study Abroad, 2009

    NJEUFACK TEMGWA Ren, Regards sur

    la protection juridique du

    consommateur africain: lecture

    compare, Penant, n 868, p. 293,

    Edition Juris Africa, Paris

    PETIPE Patern Aim, LA GARANTIE

    DES CREANCES DES COOPEC: LE CAS

    DU RESEAU CamCCUL, MEMOIRE DE

    D.E.S.S., Universit de Yaound II,

    January 2008

    SUNKAM KAMDEM Achille, La

    protection des dposants en droit

    bancaire camerounais, Mmoire de

    DEA de Droit des Affaires, Universit

    de Douala, 2004

    TEDONDJIO ROCISSE Hilaire, La

    protection du consommateur en droit

    camerounais, Mmoire de DEA de

    Droit des Affaires, Universit de

    Douala, 2004

    http://www.ohada.com/bibliographie/auteur/220/KANTE-ALASSANE.html

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