On Microfinance

Here is an encouraging article about Microfinance that was featured in Women’s eNews today. Nothing particularly enlightening about the article, but it is good to see that awareness and interest about microfinance is extending beyond the realms of finance and credit.

The article highlights how microfinance as a whole has grown by leaps and bounds in the last decade or so.

“After growing by between 20 percent and 40 percent a year for the last decade, microfinance now involves about 10,000 lenders and at least 50 million borrowers.”

But the writer also cautiously reminds readers that there is plenty of room to grow – with almost a half of the world’s population still not eligible for traditional financial services, the work has just begun.

The article high lights two issues – high interest rates and high cost per transaction. While the cost of transaction will go down eventually with increasing scale, participation of bigger financial institutions and better infrastructure, the high interest rate issue deserves a little more attention.

Littlefield says that while such rates are high, they are still much lower than the alternative, where informal moneylenders offer rates that often exceed 10 percent a month.

A study by the Consultative Group indicates that a standard moneylender loan in the Philippines is the “5-6 loan” requiring that for every five pesos borrowed in the morning, six must be repaid by evening, a daily interest rate of 20 percent.

Sure, compared to a 20% daily interest rate, any interest rate is going to look like a steal. But when it comes to pricing, microfinanciers should look beyond the service they are replacing. It should not be just a case of “There is no other alternative for them. We can get away with it, so lets charge a slightly higher rate”.

If the profile of the microfinance customers consistently show good credit rating, as they do in many parts of the world, they should be eligible for good competitive pricing. As many governments seem to have learned the hard way, the way to guarantee this is not to impose interest rate ceilings (I am not a fan of any ceilings, but if I had to choose between two evils, I would go with a ceiling on profit% earned, ensuring a reasonable margin for the microfinanciers). But the right way to fix the interest rate problem is to increase the depth of the market and develop sophisticated technologies and credit rating systems, so this segment can be sufficiently analysed and reasonably priced. Hopefully, more competitors entering the market would be just the right push in this direction.