by Richard Rosenberg: Friday, June 20, 2008
The global average is about 35 percent, but the average in Mexico is above 60 percent and in Sri Lanka is below 20 percent. Small loan sizes are the most commonly cited reason why microcredit rates are higher than normal bank rates: microcredit is a “high-touch” business, and MFIs have to process thousands of tiny transactions. But here’s a graph of MFIs in 33 countries, showing pretty clearly that loan size by itself doesn’t explain the differences between their average interest rates.
We see several other dynamics at work:
- Operating costs can be pushed up by factors other than loan size, such as geographic dispersion of rural borrowers, or an unusually expensive labor market, both of which affect costs in Mexico. Age of the MFI is another factor. Surprisingly, scale doesn’t seem to make much difference: statistical analysis by the MIX shows that economies of scale tend to level off after the MFI gets its first 2,000 or so clients.
- Political pressure can make a difference. Some countries impose a legal cap on interest rates to keep them “affordable,” even though this may restrict the availability of microloans. In other countries (like Ethiopia), the government provides a lot of microfinance at very low rates, and MFIs feel political pressure to do the same.
- Management objectives differ. In countries like Bangladesh, managers felt that high interest rates were inconsistent with their social mission, and consequently set rates at levels that would produce very little profit, at least in the early years. In Latin America, many MFIs thought that attracting commercial capital was the best way to expand their social outreach, and wanted higher profits to attract such capital. We are now seeing players in microfinance—only a few so far—whose objective is profit, pure and simple: of course, such investors want interest income to be as high as possible.
- Competition gives borrowers choices, which puts downward pressure on interest rates, forcing MFIs to become less profitable and/or more efficient. This is clearly happening in some places—e.g., Bolivia, where interest rates have dropped from 60 percent in the early 1990s to about 17 percent now. But competition doesn’t produce this result everywhere: rates have not dropped very much in Bangladesh.