The earlier blog post about micro finance lending costs raised a few questions in my mind. When I got the same from a few (very few ;)) people who had read the blog, I thought it was worth some research and a follow-up post. So here goes.
Micro finance institutions set the interest rate high since the cost of processing and managing a small loan is extremely high. Even when the micro loan interest rates are set this high, it ends up being much lower than what the small borrowers pays local money lenders and loan sharks. As a result, micro loans are the better option for the borrower who otherwise does not have access to regular banking channels. Therefore, while the costs may be high, the benefits are higher still. This is what one hears repeated multiple times wherever micro credits are discussed. And these are the assumptions that I wanted to google to find additional data.
Micro Loan Costs
The biggest chunk of micro lending costs are from administrative costs which the Micro Capital site helpfully listed as ‘identifying and screening clients, processing loan applications, disbursing payments, collecting repayments, and following up on non-repayment’.
One significant difference between the “large” loan and “micro” loan is that the absolute transaction cost per loan is higher in the latter. In a simplistic example, a commercial bank targeting the urban affluent can call or email if some piece of information is missing in the “large” loan application. If the same happens in the “micro” loan application of the rural or urban poor, the lending process changes and the loan officer or an intermediary has to travel to find the loan applicant to get that piece of data. In another example of the administrative costs, “micro” loans also result in “micro” repayments – smaller amounts paid at more frequent intervals – rather than the monthly or quarterly repayment by a “large” borrower. To process these micro repayments at frequent intervals is another requirement that burdens only the micro finance institutions and not the commercial banks. These higher transaction cost on a smaller loan amount translates into a heavier burden on the loan itself (cost relative to the loan size).
The net result of this is that the micro finance institutions have to keep the rates relatively higher if they want to at least meet operating costs and become sustainable.
That seemed to make sense for me. But that is from my expertise level in finance and economics which is almost zero. :) So, keep that in mind when I make these high-flying statements.
Local Money Lender Rates
It is most often said that local money lenders or loan sharks charge exorbitant interest rates. While the micro finance institutions may be charging higher interest rates, they cannot be called usurious when compared to these informal sources of credit. What exactly does that mean in terms of real numbers?
In an Occasional Paper titled Interest Rate Ceilings and Microfinance: The Story So Far (pdf), Brigit Helms and Xavier Reille from CGAP (The Consultative Group to Assist the Poor), there is a really helpful comparison table. For those who have having to open the bloated software called the Adobe Acrobat Reader (I am sure you can guess my feelings about Acrobat already!), I have re-created it here with due apologies to CGAP.
Annual Interest Rates of Commercial Banks, Moneylenders, and MFIs (approximately 2003):
|
Annual Percentage Rate (APR) |
|||
| Country |
Commercial Banks |
Micro Finance Institutions |
Informal Sources (ex. Money lenders) |
| Indonesia |
18% |
28–63% |
120–720% |
| Cambodia |
18% |
~ 45% |
120–180% |
| Nepal |
15–18% |
18–24% |
60–120% |
| India |
12–15% |
20–40% |
24–120% |
| Philippines |
24–29% |
60–80% |
120+% |
| Bangladesh |
10–13% |
20–35% |
180–240% |
Those numbers are enough to tell the story on their own, so I will resist the urge to analyze it further.
Controlling Operating Costs
More than anyone else, micro finance institutions are keenly aware of the costs and their impact on the rates and are therefore testing many different cost control measures.
- Grameen Bank of Bangladesh is developing a technology platform that can shift the paper-based loan process to a more sustainable computer/hand-held based one.
- BASIX in India is creating new intermediaries from old networks by converting existing telephone booths into loan repayment collection centers.
- ADOPEM in Dominican Republic is piloting a personal digital assistant (PDA) based loan process.
In addition to the traditional micro finance institutions, commercial banks are entering the micro lending market thereby creating a healthy competition in the sector. The banks are also bringing their R&D muscle to the sector thus introducing innovative technology and processes. A case in point is ICICI Banks testing of smart card technology for the self-help groups (SHGs) in India.
After all that googling, some wrist pain from clicking, and crossed-eyes from reading, the conclusion that I have come to is that micro finance sector is attempting to become more sustainable by attacking the bottom line costs which translates into lower rates for the borrowers. And I don’t have problems with traditional non-profits becoming more profit-oriented if that is done in the service of their borrowers. For that ultimately is their goal – better and sustainable service to the clients.
For anyone interested in additional reading or research, there is a wealth of material online. Here are a few to get you started:
- Wikipedia on Micro Credit – http://en.wikipedia.org/wiki/Microcredit
- The History of Microfinance: Examine the historical context of microfinance and learn more about its evolution -��� http://www.globalenvision.org/library/4/1051/1/
- Microfinance Interest Rates as a Function of Transaction Costs – http://microcapital.org/cblog/index.php?/archives/129-Microfinance-Interest-Rates-as-a-Function-of-Transaction-Costs.html
- Microfinanciers: Developing Paths to Self-Sufficiency – http://www.gsb.stanford.edu/news/bmag/sbsm0511/feature_microfinance.shtml