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Consumer Protection: the de jure vs. the de facto experience of the microfinance borrower in Egypt

Executive Summary This paper is part of a larger, collaborative research project conducted simultaneously in Egypt, Colombia, Cameroun, Kenya and India with the goal of 1) identifying the de jure consumer protection principles contained in national law, as compared to 2) the de facto consumer experience of a borrower in the microfinance industry. The research sought to examine the law as it applies to all phases of the MFI/borrower relationship: from they type and quality of the information provided to the potential borrower prior to contracting; to the execution of a loan agreement; through to an analysis of the repayment and debt collection process, including dispute resolution should a dispute arise between the borrower and the MFI. The research was lead by Hala Essalmawi, principle lawyer for the Library of Alexandria, Egypt who is a lawyer specialized in intellectual property and access to knowledge for development purposes. Ms. Essalmawi collaborated with with Jami Hubbard Solli, who at the time of the research was Senior Legal Officer at the International Development Law Organization in Rome who established IDLO’s Microfinance and Law Unit. Mrs. Solli is now a senior consultant with Consumers International, UK on financial services consumer protection. The research in Egypt highlighted a serious lack of legal knowledge of what consumer protection entails, and whether it should apply to financial services on the part of the legal profession as well as the general public. Further, it revealed a corresponding lack of advocates, and consumer protection for the poor borrowers, and the poor’s lack of access to justice, or fora in which their disputes with financial services providers may be resolved. Conversely, the research revealed serious problems with either the Egyptian collateral registration system, and with the civil judicial procedures for debt collection. The vast majority of microfinance borrowers in our research are illiterate. Prior to their interaction with microfinance institutions, they are marginalized from society and excluded from the formal financial services sector, in addition to being excluded from other institutions and services that society may offer to the non-poor. Thus, an integral point that we would like to emphasize with this research is that institutions which purport to alleviate poverty, and which target the poor and socially marginalized, should be held to a higher standards, and a commensurate

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elevated duty of care in their fiduciary relationships and business dealings with these particularly fragile client base.

On the whole, the consumer protection research in Egypt revealed numerous consumer abuses in the microfinance industry; some clearly illegal and others which are surely contrary to the stated mission of the microfinance industry to empower the poor. Our analysis revealed that abuses take place at all phases of the client/borrower relationship, with the most egregious abuses taking place when a client has difficulty making repayments. MFIs do not commonly provide a copy of the loan agreement to clients. They do not accurately and transparently communicate pricing information in a standard manner, which includes all the costs and applicable interest rate on the loan. MFIs require inappropriate forms of collateral for loans such as the promissory note or blank promissory note (often in addition to personal guarantees). They do not usually have a clear and published internal dispute resolution policy. MFIs do not explain to clients at the beginning of the lending relationship that loan rescheduling may be an option if they become unable to repay. And, in cases of repayment difficulty, MFIs resort to the criminal court system to menace clients who are late with payments, and in some instances, MFIs prosecute nonpaying borrowers such that they face incarceration. The microfinance industry was founded on the premise that financial services can alleviate poverty, and lead to social inclusion. If the rights of poor consumers are not respected then the microfinance industry is doing the poor a disservice. A primary objective in conducting this research is to engage industry stakeholders, so that we may work together to better protect consumer rights, and actually empower the poor to participate in all aspects of society. Economic empowerment cannot happen in a vacuum, and it certainly cannot occur while trampling consumer rights and human rights. In order to protect consumer rights, we need to first identify what those rights per national law, and clearly communicate this knowledge to the microfinance industry at large. In addition to educating clients about their legal rights, we must also ensure that they have actual access to legal aid and a fair forum in which to resolve disputes as they arise with microfinance institutions.

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Introduction This research was conducted with the collaboration of in country partners in Egypt (and replicated in Cameroon, Colombia, India and Kenya). In four out of five of the subject countries, the research partners were jurists who participated in IDLO’s initial project on microfinance and law1. IDLO, with its partners analyzed the domestic legislation for evidence of consumer protection principles and the existence of an industry regulatory body. Then, it analyzed actual industry practices during the contract life span; including the existence of dispute resolution policies and with specific attention paid to debt collection practices in the event of a client default. Particular attention was also paid to customer relationship management, and the role of the loan officer in the event of a default/dispute was studied. While this research underscored critical issues in all the subject countries, it is important to recognize that consumer protection in the financial services sector has rarely been a priority in any country. After the near collapse of the US mortgage lending industry in 2008 and following various microfinance industry crises related to over indebtedness (e.g. Bolivia, Bosnia, Nicaragua, Morocco and India), the issue of consumer protection has finally become a blip on financial regulators’ radar screen. Whether or not concrete actions will be taken to ensure consumers’ rights are indeed protected remains to be seen in many countries. In the dynamic microfinance sector, which is focused on poverty alleviation, we are hopeful that positive change will be more immediate, and perhaps easier to effect, because the microfinance sector is not fully integrated with the mainstream financial sector. Also, there are now several microfinance industry initiatives underway which highlight the need for increased consumer protection; including a campaign coordinated by Accion International called the Smart Campaign2 which promotes a code of conduct and seems to be an appeal for self regulation. There is also a regulatory lead initiative coordinated by the Alliance for Financial Inclusion (AFI). This research is intended to increase the dialogue with these global industry actors, and to identify ways jurists can work with the microfinance industry, its donors/investors, and the sector’s regulators to better protect poor consumers in developing countries.

1 With the exception of India, where we initially partnered with two IDLO alumni, but due to their 2 www.SmartCampaign.org

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As mentioned, there are some very serious issues in the industry from the perspective protection of the consumer, borrower and guarantors’ rights. Where there are problems, however, there are also a variety of potential solutions, which can be undertaken with the assistance of local jurists interested in development an improving the lives of the poor. In Egypt, we believe the level of actual protection for consumers is low, and it is similar in several ways to the majority of the countries that we researched. Even the issue of incarceration of defaulting debtors is an event that we have witnessed in other countries in sub-Saharan Africa. In the analysis that follows, we will illustrate that the primary consumer protection issue in Egypt relates to MFIs requiring clients, and their guarantors to issue promissory notes to the lending institution as loan collaterals. This practice has the effect of by passing the civil code, and criminalizing debt defaults. It is also a symptom of deeper problems with Egyptian legislation which does not allow for moveable goods to be used as loan collateral(s) due to possibly bureaucratic and other procedural problems. It also could be an indicator that unpaid debt is culturally viewed as worthy of criminal sanctions, as opposed to allowing for a “fresh start” through debt reorganization or debt relief through bankruptcy as other (primarily common law OECD) countries allow. Thus, in Egypt, when a microfinance client is late on a payment, or defaults, he and his guarantors are threatened with a criminal legal action, and ultimately incarceration. Debt rescheduling is rarely offered by the MFIs to the clients. The microfinance industry executives interviewed stated that it is very rare that someone is prosecuted and actually incarcerated as a result. Yet, the legal departments of MFIs interviewed would not provide data as to how (in)frequently prosecutions and incarcerations occur. Also noteworthy is the fact that multiple MFIs surveyed have in house legal departments. We presume that the bulk of their work is not contract drafting related, but rather debt collection. Further, economic court judges interviewed in both Cairo and Alexandria (Egypt’s first and second cities in population) indicated that there are numerous cases of debtors who are incarcerated for debt default (including consumer credit default, and defaults on goods being purchased on installment plans as well).3 Further, our

3 One judge admitted that sometimes he and his colleagues slip the debtor some money in court so as to pay off their debts and avoid incarceration.

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research has identified two NGOs that exist for the sole purpose of paying off the debts of incarcerated debtors.4 The judiciary and case law are not automated in Egypt, thus it was impossible to have exact statistics on the number of incarcerated, former clients of microfinance institutions; and actually having an exact number was not the goal of this research. We believe it is enough to indicate that the current practice allows for consumer rights to be abused, thus it should be fixed. While we understand the MFIs requirement for collateral or security to ensure that clients will repay (and the desire to send a message to all clients by being tough on would be fraudsters), we also believe that other, more client-friendly and cost efficient mechanisms would ensure the same high level of repayment rates. In fact, we have also begun to conduct a follow up analysis to determine the feasibility of one proposed solution; the establishment of an alternative dispute resolution system tailored to the microfinance industry’s requirements. The ADR system would allow MFIs to reschedule debts through a formal mediator, and in turn would allow clients to have a forum to resolve grievances. Thus, the final message of our research is essentially positive; there are challenges in every microfinance industry, but with the involvement of local jurists and a desire to improve the protections for consumers, particularly the most fragile of consumers, the poor, there are practical solutions available. Part I: An Overview of the Egyptian Microfinance Market The World Bank estimates that 43.9% of the Egyptian population live on less than $2 USD per day, which means that a total of 30 m Egyptians live in poverty.

The Egyptian microfinance industry, however is characterized by high demand but a low coverage of the market by the existing microfinance institutions (MFIs). In 2005, the UNCDF estimated that only 5% of the actual demand for microfinance services was then being satisfied. This low level of competition is a severe disadvantage for the typical microfinance borrower who probably lacks access to other financial services options.

4 Egyptian journalist Nawal Mustafa founded a NGO called Prisoners of Poverty to bail defaulting women out of jail. It estimates that there are close to 150 women incarcerated in the Al-Kanataf prison due to debt defaults.

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More recent industry data published by the Mixmarket (which is an industry financial reporting web site designed to increase financial transparency in the microfinance industry) in 2009 indicates that there are 1.1 m active microfinance borrowers in Egypt, with an average loan balance per borrower of $198.30 and $1.1 million cumulatively in deposits with 11,373 individual depositors (In a country where NGO’s are not legally allowed to accept deposits per Law No. 84 on Non-governmental Organizations. Thus, the NGO/MFIs that show a deposit balance on MixMarket may also be asking for obligatory deposits as a further loan collateral).5 According to the PlanetFinance National Impact Survey of Microfinance, the average Egyptian microfinance client is a 39 year old married male. He lives in a household composed of two adults of 18 years of age or older, and two dependents under the age of 18. He has not completed high school, but is able to read and write at a basic level. He works as a trader and does not have a second income generating activity. He has been in the trading business for the past three to six years, and has not formally registered his business.6 At present, microfinance in Egypt appears to be primarily for a productive, versus consumption smoothing purpose: 72% of 2,500 micro entrepreneurs surveyed by PlanetFinance indicated that they do uuse the loan funds primarily for business purposes.7 This data is consistent with our findings, though we note that there is a trend in Egypt toward offering loans to salaried individuals. The Government has recently sanctioned a move by several commercial banks to offer loans to government employees (approximately 6 m in the country) with an interest rate of 10% declining as an internal economic stimulus. Government employees could receive loans of up to 25% of their salaries8 Interestingly, the PlanetFinance study also concluded that Egyptian clients were generally satisfied with microfinance services they received, though 19% expressed dissatisfaction with the interest rates and 25% were not happy with the lack of a grace period prior to initiating repayments.9 PlanetFinance determined however that clients’ demands for product diversification were not satisfied, because most Egyptian MFIs offer only credit products, while there is actual demand for insurance (health), pensions and savings accounts (64%

5 www.Mixmarket.org (an industry portal designed to increase financial transparency as a means of strengthening the sector.); Three MFIs reported to MixMarket that they have deposits: ABWA, IDDA and RADE. 6 National Impact Survey of Microfinance in Egtypt, PlanetFinance, 2008, pg. 14. 7 Id., p. 16. 8 Egypt Today Article. 9 Id., p 17.

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surveyed desired health insurance and a pension fund, and 37% a savings account).10

The vast majority of MFIs in Egypt are structured as NGOs; the exact number of which is not known (though NGOs should register with the Ministry of Social Solidarity), but estimates are between 300 and 400. Business associations such as the Alexandria Business Association, LEAD and Dakahleya are the largest MFIs; in fact, from 2008, a total of 15 MFIs constitute 85% of the Egyptian microfinance market. 11 The largest microfinance institution per loan portfolio value in Egypt is the Assiut Businessmen’s Association (ASBA) with over USD 73m in outstanding loans. The smallest microfinance institution included in the Mixmarket data is Sohag Community Development and Children with Special Needs Association (SCDA) with over $784,500 in outstanding loans.12 After 1988, Egyptian banks also began to downscale offering microfinance services and presently comprise 22% of the market with approximately 200,000 borrowers. 13 The Egyptian banks are regulated by the Central Bank of Egypt, and were not the subject of this study. Interestingly, the National Impact Survey states that USAID is funding more than 50% of the Egyptian microfinance market, while USAID’s own audit of its microfinance activities in the country indicates that it is supporting an estimated 70% of the market, and since 1997 has actually provided $86.6m in support to seven of the nonprofit microfinance institutions operating in different regions of the country; two banks and one private organization, the Credit Guarantee Company.14 Another important actor in the Egyptian microfinance market is the Egyptian Social Fund for Development, created by Law No. 141 (The Small Enterprise Development Law). Its role is to coordinate and support between industry stakeholders and promote MSMEs. It does not have a supervisory or regulatory authority, but it is a source of funding loans and guarantees for the majority of the existing NGO/MFIs15

10 Id. 11 The Legal and Regulatory Environment for Microfinance in Egypt: Diagnostic Study with Focus on NGO-MFI Transformation Issues, Chemonics/CGAP report for USAID, June, 2009. 12 www.Mixmarket.org, Egypt, 2009. 13 PlanetFinance, p. 21. 14 Audit of USAID/Egypt’s Microfinance Activities, Office of the Inspector General, Audit Report No. 6-263-08-004-P, 2008.

15 Interview with Magdy Moussa of the Egyptian Social Fund For Development, October, 2010. The Social Fund’s microfinance department is headed by Mr. Magdy Moussa, who has extensive experience in financial inclusion in Egypt and the region. Mr. Moussa and colleague

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Also active in the Egyptian microfinance sector is the regional microfinance association, SANABEL which is based in Cairo. SANABEL conducts research and offers capacity building trainings throughout the Arab region, with an highly attended annual conference hosted in a different state each year, and which highlights the state of the industry; raises industry concerns and issues annual awards to MFIs for their industry progress and transparency. It has 17 MFI members in Egypt, and 75 members throughout the Arab region.16 It is our impression that SANABEL’s events and stature in the industry appear to overshadow that of the national Egyptian Microfinance Network. Egypt does not have a public credit bureau, but in 2005, i-Score, a private company established a credit information system utilized primarily by the commercial banks. I-score has also partnered with the World Bank’s International Finance Corporation’s Global Credit Registry Project to promote the use of I-Score amongst MFIs. At present, the majority of MFIs do not participate in the formal credit information sharing system primarily due to cost. It costs a MFI forty Egyptian Pounds to register each client, and twenty Pounds per inquiry per client.17 Given that Egyptian MFIs are far from satisfying existing client demand, it is unlikely that they are experiencing high enough levels of client overlap; or instances of clients taking out loans from multiple MFIs to convince them to pay to participate in credit information sharing. Generally, high levels of client overlap are associated with client over indebtedness. When a microfinance industry begins to experience high levels of overlap, it is generally more likely to consider participation in a credit information sharing system. On the whole, the Egyptian microfinance market presents a less mature market than other African, Asian and certainly Latin American markets. It has yet to experience an over indebtedness crisis, or other client driven repayment problems. Its level of development is perhaps on a par with its Arab neighbor Jordan, but yet less developed than Morocco which has recently experienced a client over indebtedness crisis.

Ms. Nevine kindly agreed participated in several meetings with IDLO and HNMC researchers in order to better understand the industry and legal framework.

16 http://www.sanabelnetwork.org/en Sanabel’s Executive Director, Ranya El Badeki also kindly offered her availability to IDLO researchers on several occasions. 17 Interview with Magdy Moussa, Egyptian Social Fund for Development, Oct., 2010.

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Part II: The Egyptian Legal and Regulatory Framework for Financial Services and Consumer Protection A. Legal Structure and Applicable Regulatory Authority(ies)

Egypt at present has proposed draft regulations for microfinance companies which will change the current landscape of the industry that is currently dominated by MFIs structured as non profit, non governmental organizations pursuant to Law No. 84 of 2002; NGOs (Associations and Non-Governmental Institutions), must register with and receive a license from the Ministry of Social Solidarity (MSS). Regulation of registered and licensed MFIs then consists of the MFIs submitting copies of their board meeting minutes to the Ministry; the same requirement is placed upon other non-microfinance charities registered with the Ministry. No specific financial monitoring or regulation is conducted by the MSS. At present, the only applicable quality control of microfinance institutions appears to be the following limitation on who cannot form an association: persons who have a final court ruling … with a finding of moral turpitude and dishonesty are barred from founding an association [unless] he has been rehabilitated.18 During the second half of 2009, a potentially landscape-altering legislative change for NGO/MFIs occurred. The law for Non-banking Financial Markets and Instruments was enacted, which established the Egyptian Financial Supervisory Authority (EFSA) as the unique market regulator.19 The law states that the EFSA will supervise all non-bank financial markets and instruments, including microfinance, the capital market, insurance, mortgage finance, financial leasing, factoring and securitization. The EFSA is currently in a consultation period on the new regulations, and given the instability in Egypt at present, we do not expect new regulations to issue in 2011.

B. Limitations on Scope of Services by NGO

A potentially restricting clause in the NGO law is Article 22, which states that in all cases, the association shall be prohibited to join in financial speculation.20 Lending to the poor and illiterate who do not necessarily have a business track record could certainly be considered an inherently speculative financial activity. And, for most of the NGO/MFIs, their primary and in some cases sole function is to provide credit to the poor.

18 Law No. 84, 2002, Chpt. 1, Art. 2 19 Law No. 10 of 2009 (published online in English at 20 Id., Chpt. 2, Art. 22

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The NGO law also states that the primary purpose of the organization shall be for other than gaining a physical profit. 21 C. Interest Rate Cap pursuant to the Civil Code NGO/MFIs are proscribed by the Egyptian Civil Code, Article 27 which From charging interest rates beyond 7% for lending activities, (commercial banks are excluded from this cap).22 All of the Egyptian NGO/MFIs surveyed are providing loans at double, and some at triple the applicable interest rate cap. Further, Article 27 specifies that if the parties agree to an interest rate above 7%, the rate will be reduced to seven percent and any surplus that has been paid will be refunded. Similarly, any additional management fees or charges surpassing an interest rate will be considered as an attempt to disguise the interest, and will be subject to reduction, unless the NGO/MFIs can demonstrate that these additional fees were actually for other services rendered.

It is probable that this is the reason why NGO/MFIs are not keen to reveal their interest rates, and do not publish the applicable rate on their loan agreements. Further, the of the three institutions that allowed us accesss to their loan agreements, none stated the applicable interest rate on the contract.

D. Allowable Sources of Funding

Another potentially complication for leading NGO/MFIs is that the law forbids them to collect funds from abroad, whether from an Egyptian or foreign person, or a foreign quarter or its representative inland. Though, the law does provide that exceptions can be granted by the Ministry of Social Affairs.23 If all of the leading NGO/MFIs are granted exceptions (as evidenced by the support of USAID), it would seem that this restriction is a burden without a purpose for the industry.

E. Legislation Impacting MF Transactions: Loan Collateral and Debt Guarantees

It is customary in Egyptian society to use promissory notes to purchase items on installment, whereby the purchaser provides a number of promissory notes equal to

21 Id., Chpt. 1, Art. 1 22 Egyptian Civil Code, Art. 23 Id., Chpt.2, Art.17

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the number of remaining installments due on the total balance. (In fact, books of promissory notes are sold in stationary stores).24 Upon payment of the specified amount, the seller would then return the signed promissory notes as the borrower pays the installment due. In the microfinance industry, the standard MFI practice is to request blank promissory notes from both the borrower and his or her guarantor(s). The legal fiction in the case of the microfinance borrower, which allows for a criminal prosecution should he default, is that he is in possession of the funds from the MFI, in trust for another entity (the bank or funder of the MFI), and the act of not repaying the funds is criminal, and the equivalent of embezzlement pursuant to Article 341 of the Penal Code. In fact, the microfinance institutional contracts which we have reviewed usually state that: I, the undersigned (borrower/debtor) have received from (creditor/lender) an amount of $ _____ to deliver to ____.

Upon failure to pay the debt, the creditor shall report this to the competent authorities, which in most cases is the police. The existence of the written contract signed by the borrower constitutes proof of the crime. At any point in the investigation, or at any point during the subsequent trial, including post sentencing, a defaulting debtor can repay the debt, and face no further consequences. The debtor could also allege that the contract is in effect a civil agreement and lacks the true character of receiving money on someone else’s behalf (as an agency relationship). Thus, the promissory note is merely incidental to a credit agreement, in which case the court shall investigate the case by accepting testimony of witnesses.25 A field study done by a judge of the first instance court of Alexandria determined that for every 200 misdemeanor debt default cases, 75 of the cases involved promissory notes and the debtor normally failed to prove the civil nature of the debt relationship.26 Further, there is a similar criminal penalty affiliated with the issuance of dishonored checks, however it is treated as a more severe offense.27

24 Interview with Judge Hisham Bahloul, First Instance Court of Alexandria, February, 2010. 25 Id. 26 Id. 27 Check offenses designated by Articles 336-337 of the Penal Code are considered crimes of honor, thus more egregious than that of unpaid promissory note.

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F. De Jure Consumer Protection There is an all purpose Consumer Protection Act (No. 67 of 2006) in effect in Egypt which also established a Consumer Protection Authority to monitor all businesses providing goods and services to consumers, including financial services. Though financial services are not specifically mentioned in the Act.28 Interestingly, article five of the Consumer Protection Act requires that when the consumer requests it, the supplier must provide the consumer with an invoice concerning the transaction or agreement related to the product; including in particular the date of the transaction or agreement, the price, specifications, nature, type, quantity and any other data of the product stipulated in the Executive Regulations of this Law. Article six of the Act further provides that every supplier and advertiser shall provide the consumer with correct information concerning the nature and characteristics of the product and avoid anything that would create an incorrect or misleading impression to the Consumer or lead to the Consumer falling into confusions or mistake.29 Microfinance institutions are for the most part not providing copies of loan agreements to borrowers in Egypt.

The Consumer Protection Authority also posts a complaint registration procedure on its website, but does not publish information on the volume and nature of complaints, nor the actual procedure for resolution. The in country partner interviewed the head of the Authority for this research who indicated that financial services were beyond the scope of its authority, and stated that financial services were the responsibility of the Central Bank of Egypt.30 The Central Bank however regulates commercial banks, not NGO/MFIs. The new, and intended future regulator of the sector, the Egyptian Financial Supervisory Authority has published a list of internationally accepted principles of microfinance consumer protection; including, but not limited to the following: • Clients have the right to know the interest rates, fees and other charges they are paying;

28 Consumer Protection Act, No.67 of 2006 (published in English at http://www.cpa.gov.eg/english/legislations_rules.htm) 29 Id., Art. 5-6. 30 Interview by telephone with Mr. Said El Afy, October, 2010

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• Clients should not be offered loans more than their repayment capacity;

• Clients should be treated in a fair, disciplined and respectful manner;

• Clients should have an opportunity for communicating their feedback on the products and services;

• Clients' personal information should be kept confidential and should not be disclosed without the clients' prior consent. However, as referenced above, it is not effectively regulating microfinance at present, and the above mentioned principles are not enforced in the Egyptian microfinance industry.

Part III: Research Methodology and Limitations The research focused initially on identifying the applicable law on consumer protection pursuant to a desk review of the applicable financial services and consumer protection related legislation. IDLO then conducted extensive interviews with Microfinance industry executives, managers, loan officers and clients in an attempt to dissect the entire lender/borrower relationship and the commercial practices of leading MFIs throughout their relationships with clients. Interviews were intended to analyze the pre contractual phase (ie advertising and how clients found the service provider); contracting (what information is supplied to the consumer on the loan terms) and post contract phases (including dispute resolution and debt collection). Interviews were also conducted with economic court judges, and other industry stakeholders such as the Social Fund, and representatives of regulatory bodies. Our initial premise was that there is either a disparity in the de jure vs. de facto consumer protection in the industry; or there are significant opaque areas in the legislation and regulatory gaps, and as a result, the MFIs are not fully respecting consumer rights throughout the lender/borrower relationship. As in the other four countries analyzed, we analyzed MixMarket data to identify the top ten microfinance institutions by market share (or gross portfolio size), which also belong to the regional microfinance network SANABEL.31 In Egypt, two additional MFIs were invited to participate due to previous difficulties establishing contact and involving the MFIs amongst the top ten.

31 Our rationale was that if a MFI belongs to a microfinance network and submits its financial data to MixMarket, this is an indication of financial and operational transparency.

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The microfinance organizations listed below in Chart I were all contacted to determine whether they could be interested in participating in the research. The institutions highlighted in green participated fully in the research in that they allowed our researchers to interview personnel at the executive level, a minimum of two loan officers and at least 10 clients (*ABA also allowed us additional interviews with clients from diverse branches). Further, full participation and the green color also indicates that the MFIs either provided copies of standard form contracts, or allowed IDLO researchers to review the contracts in their offices. It should be noted that no MFI allowed us access to defaulting debtors, and the MFIs which allowed us access to active borrowers did so only in the presence of the loan officer or other institutional employee who remained with the borrower during the interview. This could potentially influence clients’ responses due to the desire to please the loan officer, and to continue to have a positive lending relationship. MFIs highlighted in yellow participated partially in the research; either by allowing access to only some of the personnel we wanted to interview (in most cases only at the executive level), and not providing copies of contracts or access to clients. And, the MFIs highlighted in fuschia did not respond to our repeated attempts to contact them for participation in the research. Interestingly, of the top four performing microfinance institutions in the country, three fully disclosed contracts and provided full participation in the interview phase of our research. Chart I.

Organization Loan Portfolio No. of Clients ASBA 73,044,374 368,333

ABA* 38,501,957 134,922 DBACD 24,070,314 104,234 Lead Foundation 22,176,175 172,691 ESED 19,724,475 104,964 Al Tadamun 10,798,152 90,714 SBACD 8,766,050 32,307 CEOSS 6,229,943 38,878 FMF 4,578,856 18,390 ABWA 3,655,800 17,931 RADE 2,868,169 16,209 IDDA 1,681,712 11373

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Our research benefited from the fact that we had previously met several industry leaders either through IDLO’s microfinance regional trainings or at SANABEL conferences; such as Mr. Motaz El Tabaa of the Alexandria Small Business Association (ABA); Mr. Khalid Al Gazawi of the First Microfinance Fund and Ms. Wafaa William Of CEOSS. Mr. El Tabaa of ABA was particularly helpful, insightful and supportive of IDLO’s research. He not only spent hours with interviewers on various occasions, but he also devoted many hours to providing input for the desk review of existing legislation in Egypt that impacts MF operations. Mr. Al Gazawi of FMF was also very supportive of our research and allowed us access to managers, loan officers and clients in good standing to interview. FMF’s internal communications policy, however did not permit us to have copies of FMF’s standard form loan agreements. Ms. Wafaa William also kindly agreed to be interviewed, albeit in a group interview with four other CEOSS managers present. She declined to allow us access to CEOSS clients for purposes of conducting interviews, citing that this a violation of clients’ privacy. The issue of consumer protection in the micro financial services sector is quite sensitive in general, thus MFIs were understandably reluctant to participate in a study done by an organization composed of lawyers (often perceived in developing countries as less than helpful), particularly when they were not acquainted with IDLO’s work. Further, due to the insecurity engendered by an unclear legal and regulatory framework in Egypt, it is also normal that MFIs would be hesitant to air potentially negative facts about their own operations, or the industry. IDLO did attempt to reassure the industry that this research was not a finger pointing exercise, but rather it is intended initiate a dialogue with industry actors and to offer its collaboration in resolving identified problems. Apparently, this was not an entirely persuasive argument given that five of the top 10 MFIs refused to respond to repeated inquiries. The desk review of applicable Egyptian legislation was completed by Ms. Hala Essalmawi, an Egyptian lawyer who coordinated a team of in country researchers. Further, a debt of gratitude is also owed to Judge Hisham Bahloul.and his team of graduate law students who conducted procedural legal research and who clarified issues of judicial procedure, commercial and civil law, promissory notes and insolvency/bankruptcy issues.

Part IV: De facto Application of Consumer Protection Principles in the Microfinance Sector

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Of the fifty clients that researchers were allowed to interview32, 32% indicated that they were illiterate, and additional 32% possessed only a primary school level of education. This indicates that MFIs should apply protective mechanisms to ensure that 1) the client understands the terms of the loan agreement, as well as 2) the implications of the debt, including applicable late payment penalties or consequences of default; and 3) that the client has the requisite financial literacy level and position to utilize the funds for a productive purpose, which will allow the borrower to repay the debt in the specified time frame without undue hardship. More importantly, it should be probable that a loan will improve his over all financial position or asset base. The clients interviewed, however indicated that as a requirement to receiving a loan they must attend training sessions which focused on institutional objectives and borrower rights and obligations. There does not appear to be a deep analysis or any business planning to determine whether debt is appropriate to the client’s business needs. Again, the clients surveyed are from only three institutions, thus this is be too small a sample to draw conclusions for the whole industry, yet the three MFIs which allowed clients to be interviewed are the industry leaders. Thus, it is doubtful that MFIs that are less successful than these three are providing more in terms of client education.

Regarding financial literacy and the capacity to understand the terms of the loan agreement, clients for the most part indicated that interest rates, repayment terms and consequences of default were explained to them in detail (40 of the 50 interviewed). Less clearly communicated were the issues of how to modify a debt, options for dispute resolution and the right to data privacy (only 10 of 50 indicated that they were informed of these issues by the MFI). In fact, loan officers globally seem extremely reticent to communicate to debtors that there is an actual debt rescheduling option available, and what the applicable procedure is (generally obtaining the branch manger’s approval). Despite their assertions that interest rates were clearly explained to them, none of the 50 interviewed could correctly explain what APR was or how to calculate it. In addition to orally communicating terms, MFIs should provide the client with a copy of the executed agreement. Ideally, because clients are illiterate, a standard form agreement should be posted on the MFI’s website and made available in the branch so that potential clients may have a trusted, literate individual read and explain the contents to them.

32 Clients of only three MFIs: ABA; Lead Foundation and DBACD.

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Only six of the 50 clients surveyed were provided with a copy of their loan agreement. With regard to knowledge of protections that Egyptian law affords consumers and borrowers, those interviewed for the most part responded that they did not know. One client indicated that by law the responsible entity should facilitate a payment procedure for the defaulted borrower. Interestingly, when clients were asked if they had a complaint or legal problem, where could they go to obtain assistance; the choices were as follows: a financial ombudsman, MFI networks, legal aid, private legal counsel or the MFI management itself or other. Forty-six percent of clients responded that they would avail themselves of the MFI management, and the remaining 54% responded “other.” This may be an indicator that the microfinance borrowers do not perceive that they have access to any formal dispute resolution procedure.

Forty-two of those clients interviewed were required to provide a blank promissory note or a check as a collateral. And, 18 of the borrowers or 36% indicated that they were at one time behind on payments, of which only 2 borrowers indicated that the MFI made an attempt to restructure their loans. All the clients interviewed were non-defaulting clients selected by the MFIs for interviews, and accompanied by the loan officers themselves. On the whole, our researchers perceived that there was a genuine and high level of trust and respect between the loan officers and clients. Yet, there is always the possibility that client responses were influenced by the loan officers’ proximity and the clients’ sense of loyalty to his only source of financial services. Only one of the clients interviewed stated that she had a choice between the selected MFI and other service providers.

Part V: Recommendations for Protecting the Financial Services Consumer A. Contents of the Loan Agreement Loan agreements should be drafted in a more transparent manner so as to inform clients of the applicable interest rates per annum. Agreements should also clearly indicate all total fees, not merely providing an applicable payment schedule (which is helpful, but insufficient for the borrower to assess the total costs of a loan).

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Loan agreements should also clearly indicate whether the borrower has a right to reschedule a loan should he or she be unable to repay. The MFI itself should establish clear rules for rescheduling which are communicated to loan officers and clients; preferably by also posting in branch offices. While we appreciate that loan rescheduling should be a last resort, it should not be a mystery to clients. The MFI could also indicate that if a rescheduling is approved by the appropriate MFI committee or branch officer, that may negatively affect the client’s credit history with the organization and negatively impact his/her ability to get another loan in the future, or to act as a guarantor. A copy of the loan agreement should be provided to clients, and standard form agreements should be available in the branch offices for potential clients to review prior to becoming borrowers. B. Sales Procedures MFIs should also consider the practice of allowing for a cooling off period of several days in which the client has signed a loan agreement but decides to rescind the agreement, at no cost or penalties. This period would allow for clients who cannot read to receive input and counsel on the contents of the agreement for someone who has a higher level of education. Cooling off periods are also effective instruments against impulse buying and high pressure sales tactics. In order for cooling off periods to be effective, however, MFIs need to provide their clients with a copy of the loan agreement. As previously mentioned, the majority of the MFIs interviewed are not providing a copy of the contract to borrowers. Apparently, this document is maintained as a further collateral in and of itself and only provided to the client upon extinction of the loan. (MFIs can still maintain an original agreement and provide a copy to the borrower for his/her records.) MFIs should also consider publishing their loan and guarantee agreements online, such that their clients are better informed about the nature of a loan contract prior to becoming a client. C. Reducing Risk of Default through Credit Information Sharing Currently, there is no credit information sharing amongst the NGO/MFIs, but an initiative has begun, sponsored by i-Score and the IFC to share microfinance institutional client data. Apparently, the MFIs are not keen to participate because the costs are high per low value of a microfinance loan. The Jordanian microfinance industry has resolved this issue in a unique manner and has drawn up a private contract amongst the leading 10+ MFIs to share client data with the support of their financial software manufacturer, Delta Informatics

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(thereby eliminating the need to involve a large consumer data collection company as well as the high transactions costs). All Jordanian MFIs participating in the agreement use the same loan tracking software produced by Delta which also created the information hosting platform, and is a party to the private contract with the MFIs. Thus, Delta is able to make a profit by selling software design services, rather than relying on an income stream from managing the debtor data and related credit reporting.33 Costs for maintaining this system are several hundred dollars per MFI per annum, and it would seem that this could be a feasible solution could in Egypt as well. Having a credit data sharing, reporting and scoring mechanism in place would also reduce the risk of micro lending, and allow the MFIs to discontinue the current practice of requiring borrowers and guarantors to provide blank promissory notes as collateral for debts. This practice is not only unfair to clients and their guarantors, but it has the potential to unduly burden the judicial system and to pass on microfinance operational costs to the public and the State.34 Further, using the criminal justice system as an weapon when debts are incurred in commerce is highly inappropriate and potentially a human rights violation. Egypt has signed the UN’s Covenant on Economic, Political and Social Rights, which dictate that debt is not an appropriate justification for incarceration.

D. Debt Collections Procedures As noted above, the NGO/MFIs rely on the practice of taking promissory notes as a potential arm in the debt collection process. It is not clear whether loan officers are instructing their clients that an unpaid debt could result in incarceration, but is clear that they are not freely offering rescheduling as an option to the client in lieu of default. They insist that they must be very, very sure that a client cannot repay (and is not attempting to defraud them). The issue of the functionality and/or efficacy of the collateral registration system in Egypt was beyond the scope of this research. However, the fact that MFIs do not demand housing or land titles; car titles or other moveable goods as collateral for microloans would seem to suggest that there is a related problem with the registration system which should be investigated further. Further, the use of the blank promissory note implies dysfunction in the civil judicial procedure regarding the enforcement of debt judgments. Thus, it is

33 Interview with Marwan Hamdan, founder Delta Informatics, Nov. 2009. 34 One judge we interviewed stated he presided over between 100 to 150 consumer debt default cases per week in his Cairo court. Debts at issue were all very small amounts for the most part related the inability to comply with the terms of installment purchases.

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advisable for the microfinance industry to explore the viability of alternative dispute resolution processes to address collection challenges. For example, mediation or arbitration could be potential solutions to the burdensome and litigious nature of debt collection (which puts the MFI in an adversarial position with persons it was trying to empower). Further, establishing an ADR system for microfinance would provide consumers with a forum in which to voice complaints and grievances where there is currently none. IDLO has engaged the Harvard Law School’s Negotiation and Mediation Clinical Program (HNMCP) to conduct a feasibility study under IDLO’s direction to determine whether ADR could be a feasible solution to the inherent conflictual nature of debt collecting in the microfinance industry. Results of the HNMCP will be final at the end of January 2011. Intial findings have revealed that most MFIs would be in favor of the establishment of an ADR system for the industry. The Social Fund’s M. Magdy further noted that MFIs could be incentivized to participate by establishing an insurance fund to cover defaults which could be offered in conjunction with the ADR program.35 Judge Tarek of the Egyptian Economic Court indicated that the Economic Courts could also be a potential partner to implement ADR for the microfinance industry, but noted that it may be necessary to advocate for supporting legislation on point to ensure that MFIs must collaborate.36

C. Additional Recommendations Both the Egyptian Social Fund and USAID provide substantial economic support to the Egyptian NGO/MFIs. Either or both of these entities could demand that a higher level of consumer protection is a prerequisite to receiving additional funds. Further, they could also sponsor a variety of intiatives designed to improve consumer protection in the industry such as;

1) the drafting of model contracts for the industry to use which are fair and transparent loan and guarantee agreements. Local jurists familiar with the microfinance industries objectives and challenges are available to assist to strengthen consumer protection initiatives in the country;

2) the establishment of an ADR facility tailored to the requirements of the microfinance industry and financial disputes of a low value (perhaps with the partipation of the newly established economic courts); and

3) the establishment of a legal aid clinic perhaps with the collaboration of law students and faculty of the Universities of Alexandria and Cairo who could utilize the opportunity to teach a clinical course on consumer rights and financial services.

35 Interview with M. Moussa of the Egyptian Social Fund, October, 2010. 36 Interview with Economic Court Judge Tarek, October, 2010.

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4) Research regarding how to deal with eventual industry problems related to consumer over indebtedness, such as the applicability and functionality of personal insolvency or bankruptcy laws for the reorganization of debt and/or debt relief.