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News tagged as "transparency"
January 8, 2013

Behind the contracts: let your left hand know what your right hand is doing

Tags: microfinance, responsible finance, transparency, consumer protection | by Verónica López Sabater & Álvaro Martín Enríquez, Afi, Analistas Financieros Internacionales

Contract agreements signed between a financial institution and its clients are unilateral agreements designed by the former and – eventually – accepted by the latter. They are also called “contracts of adhesion”, meaning that one of the parties adheres to its contents. There is no room for further negotiation as it is common practice in other types of private contracts: you (client) either take it or leave it. Fair enough, those are the rules of the game, aren’t they?

Financial institutions designing a contract of adhesion are in charge of caring for the interest of one of the parties (their own). In the specific case of standard form agreements ruling financial relations among clients and institutions, the interest taken care of by the institution’s legal department is twofold: on the one hand, regulatory compliance; on the other, making sure that funds will be appropriately recovered.

The second objective is based on the establishment of sufficient guarantees to allow the lender to timely recover the funds lent to the debtor. Who defines “sufficient”? The authority should establish the minimum requirements that any binding contract should contain, in terms of transparency, fair treatment and client protection. However, there are jurisdictions where these parameters are non-existent, as it is the case of Guatemala, for instance. What happens then when there is no referee controlling for the proper compliance with the (oops! non-existent) rules of the game?

Many readers of this post will have often read standard form agreements regulating the relations between clients and financial providers. Fewer will have probably searched for abusive or inappropriate clauses. And a smaller set will have had the chance, as we had, of searching ugly wordings in those contracts: it is surprising that many of the apparently inappropriate clauses are not binding and have never been activated, even when the activation cause has taken place. Then, why are they “black on white” in many contracts? Our bet – based on empirical evidence – is that no one at the financial institution has ever carefully read the contracts that are being offered to clients. How could that be so? That is not an easy question to answer, unless you track the process behind the elaboration of contracts and reach the ultimate responsible: the legal department. And that is what we did.

-          [Afi] Good morning! Could you tell us what your utility function is? Do you ever take in mind the clients’ perspective?

-          [LD] Not really. I write contracts when asked to, usually when new products come out. And I usually build up on existing contracts, just updating the new product’s attributes.

-          [Afi] Does anyone control for the quality of the contracts?

-          [LD] Yes, that’s what I do! 

Unless contract designers are to follow specific guidelines that protect the client, contracts will always overemphasize protection of the financial institution’s interest, since that is the objective function of the legal department, which is fair enough. However, as in the human body, financial institutions are live organizations that require a properly working central nervous system that integrates the information that it receives from, and coordinates the activity of, all parts of the body, responsible for controlling behavior, alerting and helping react to both external and internal factors. In other words, the institution’s left hand should know what its right hand is doing, which is exactly what we suggested in a previous post: the key is to mainstream client protection principles, standards and practices throughout the whole organization, as a nervous system does. The question is: how can this be done?

A responsible finance / transparency department (name it as you wish) should provide the final OK to all new products, all new (and old) contracts, all new (and existing) advertisement materials, and so forth, to make sure that the clients’ perspective is considered in all dimensions.

The retail banking business – including microfinance – builds on trust, and clients should be looked at as partners, not as enemies. An easy first step towards applying the abovementioned suggestion would be the following: take a closer look into contracts, keeping the distance – put yourself in your client’s shoes. It is quite a unique experience that we highly recommend.

Initiative financed by: Initiative financed by AECID
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