When hearing about microfinance, people are usually amazed (at the concept) and appalled (at the perceived high interest and fees of the microfinance institutions – or MFIs). Indeed, interest and fees relative to portfolio average 31% (23% in real terms).
If microfinance is serving mostly poor and excluded people, shouldn’t MFIs subsidize the loans? Are they taking advantage of the poor?
A few facts:
- Most poor people don’t have access to financial services
- When they have access, it is often at exorbitant rates from money lenders
- They value lower interest rates less than one would think
That being said, most MFIs don’t charge high interest because they can. They charge high interest because they need to in order to cover their costs and stay in business. And, despite their seemingly high fees, they offer a cheaper alternative to existing sources of finance.
An MFI’s main costs are:
- Loan loss provision
- Financial costs
- Operating costs
A look at some numbers
Loan loss provision are low (2% of loan portfolio) due to low delinquencies. Financial and operating costs are higher, at 10% and 20% respectively. Donor grants and subsidized loans (from Kiva lenders and other social investors) allow MFIs to control their financial costs to some extent, but many MFIs are not allowed to mobilize a cheap source of funds, savings. For small, new MFIs, or MFIs that offer very small loans, operating costs average 28%, double that of MFIs that offer larger loans to small businesses. Small African MFIs that are not yet sustainable reach 52% average operating costs!
It is much more expensive to administer 1,000 loans of $100 than one loan of $100,000. For a typical MFI reaching the poor, that would represent 1,000 client visits on a weekly or bi-weekly basis, travelling in areas that can take a day or more to reach. That MFI would also likely combine the loan with other services such as financial or health education. Compare this to the client getting a $100,000 by visiting the bank and showing its credit history…
The appropriate benchmark
Rather than judging MFI interest rates in a vacum, one needs to take a closer look at the services offered by the MFI, the clients it is reaching, and the areas where it works. Organizations like MIX and MF Transparency are working to compare interest rates and fees across MFIs that share similar characteristics. This type of analysis is much more meaningful when trying to determine whether an MFI is charging a “fair price” for its unique services than comparing microfinance interest rates to the traditional banking sector.