In defense of interest rates

Interest rates have always been a hot topic in the discussion of microfinance. Simply put, they are high, and sometimes very high. It's no surprise that people ask "But isn't microfinance supposed to help the poor? Aren't these interest rates hurting them?" Where to begin with answering this question. Microloan interest rates are not this high without good reason, in fact, it's what's keeping the industry self-reliant as opposed to becoming a donation-based business. This is extremely important if microfinance institutions (MFIs) want to increase their impact by expanding their services to the poorest of the poor. Expansion is expensive, and expanding to clients that pose larger risks than their middle class counterparts, well, that's even more expensive. High interest rates allow MFI's to factor in those risks without compromising quality services.

I read somewhere that it is inappropriate to compare microcredit interest rates to commercial bank interest rates. The argument was that commerical banks deal with much larger loans and transactions so the cost per unit of a commercial loan is much less than the cost per unit of a microloan. It is more costly to give out several small loans than a few large ones. Secondly, commercial banks will always recieve larger subsidies than an MFI would recieve, thereby making the risks incurred by each incomparable. Commercial banks loan to customers with more or less stable recorded financial histories, sometimes with the secure backing of subsidies and collateral meant to cover 80%-100% of the loan value. MFI's loan to clients with little or no recorded financial history, with the secure backing of collateral worth at most 80% of the loan value (at least in Prisma's case), or a guarantor. The target clientele for each is different, the risks are different, the costs are different, and the services are different. MFI's must charge for this difference.

I want to delve into what I mean by the risks that make microfinance more costly. When a client repeadtedly fails to pay on time, MFI staff will travel to the client's home or business to voice the concern and come up with a payment plan. From my own experience at Prisma, traveling to the client's home/business doesn't mean taking a 10 minute drive down the nicely paved roads of the city. No. I'm talking the very low-income areas on the outskirts of the city, where you find dirt roads, pot holes galore, gang-infested neighborhoods (a Prisma client was killed by gang memebers last year for going to the police about a robbery), no street names, and to top it off the client may not even be there once you arrive. I admit this is not always the case, but it is about 65% of the time.  My boss Susan and I have already gone 3 times to see the same client about her late payments, with traffic and road conditions making it 45 minutes each way. And she's not the only client we've made repeated visits to. Like I said, risks are expensive.

Let's not also forget that MFI's have to take out loans to operate and have to pay interest on those as well. If clients fail to pay their dues, MFI's suffer the consequences on many levels. Every month Prisma has to pay its own dues to the larger banks where it has loans. If the clients pay late, Prisma pays late, jeapordising its own financial integrity.

Another thing I want to point out that Susan mentioned to me is that the people who have long been shunned by formal banks for all these years are the same people who are willing to pay high interest rates for the personalized and amicable attention they receive at MFI's like Prisma. I've personally heard a few clients complain about how they are made to feel when entering large banks: like lesser people. Large banks demand clients to put valuable assets at stake in order to take out a loan. Many of Prisma's simply don't have that much to offer save maybe a TV or a fridge.  But MFI's understand the value of these items to the client and that is why they will consider those assets as worthy for a loan. MFI's must consider assets beyond their face value, and more in relation to the client.

Communication is also something that clients pay for. My first few weeks here I watched in amazement as Susan conversed with clients in almost street talk about Prisma's policies and application procedures. She speaks to them as if they were her nextdoor neighbors of 10 years. That is what clients pay for: comfort and simple conversation.  

This is my defense for high interest rates on microloans. This is not to say that interest rates haven't had their fair share of attacks and accusations. Interest rates have been wrongly attacked as a result of irresponsible management and over-lending in places like South Asia and Latin America. These issues also need to be addressed and discussed. In my next post, I will discuss how the abusive enforcement of payment and lack of oversight have damaged microfinance's reputation and have made the industry's operations subject to government intervention, especially when it comes to capping interest rates. I will conclude by saying that high interest rates are what is keeping the microfinance industry afloat, giving it an opportunity to expand to poorer clients while covering the costs. They are more than just the interest on top of loan. They lead to quality services, personalized attention, and an opportunity to expand to those who are financially isolated.