Non-Transparent Product Pricings by Afghan MFIS and the Impact of “Cognitive Bias” on Borrowing Decisions of Microcredit Borrowers

Abstract

Microfinance has increasingly become a fashionable topic in the field of finance. The mission of microfinance worldwide is to provide financial access to the poor and low-income so as to help them setup small scale business activities and/or expand their existing ones for the purpose income generation and poverty reduction. The concept of providing the Afghan poor with access to financial services came to Afghanistan in 2003. Besides experiencing the challenge of becoming financially sustainable, MFIs in Afghanistan are facing security and religious constraints. MFIs in Afghanistan have not been able to cover their operating costs despite charging high interests and Microfinance Investment Support Facility for Afghanistan (MISFA) has been covering that portion of their costs so that MFIs remain operative on the ground. Considering MISFA’s priority for financial sustainability of MFIs and “cognitive bias” of Afghan borrowers, MFIs have been charging very high interest rates using non-transparent pricing strategies associated with extra hidden costs such as initial loan processing fee and compulsory deposit requirements. The paper finally concludes that “cognitive bias” negatively impacts borrowing decisions of borrowers given their lack of finance education and non-transparent pricing mechanisms by MFIs coupled with extra hidden costs. Accordingly, MFIs are solely relying on charging high interest rates while receiving subsidies from MISFA enabling them to cover their operating costs. For better serving the Afghan poor, transparency in MFIs’ pricings, and enhance market competition three policy recommendations are suggested: regulation of MFIs’ pricing strategies, awarding innovation and efficiency, and adoption of declining balance method by MFIs.