Why Are Microfinance Interest Rates So High?

> Posted by Elisabeth Rhyne
At next week’s Microfinance USA conference, I’m participating on panel about microfinance interest rates, representing The Smart Campaign. The Smart Campaign aims to make client protection principles a hallmark of microfinance around the world, and one of our most important commitments is transparent and responsible pricing. It’s important for supporters of The Smart Campaign in the U.S. to get aligned with their counterparts in developing countries about what responsible pricing looks like. This panel is an opportunity to do just that.
Often, people whose work is U.S.-based suffer acute sticker shock when they hear about interest rates charged in international microfinance. At rates above 20 percent, most Americans start getting uncomfortable, and when they hear that in some places interest rates rise as high as 100 percent or even more, their moral outrage beepers start to malfunction. This is unfortunate, because when we are in a state of high outrage, it’s hard to listen.
I’m hoping that at the upcoming panel we will be able to set aside moral judgment just long enough to examine the factors that determine international microfinance interest rates.  Only after we’ve established a deep understanding of the causes of high interest rates in their own contexts do we dare make judgments about morality.
Here are just two things I hope we can consider dispassionately:
The arithmetic of tiny loans. Interest rates are constrained by the uncompromising arithmetic of the three main elements of administrative cost, all context-specific. How big are the loans? What is the maximum loan officer caseload? How much are loan officers paid? A lender making $1,000 loans in a dense city market with a labor market that allows modest loan officer salaries can charge a much lower interest rate (think Bolivia, with rates in the 20s) than a lender making $100 loans in the rural parts of a middle income country where loan officers earn a lot (think Mexico with rates in the 60s).
The need for sustainability to ensure coverage and permanence. Do we think prices should support lender sustainability? Microfinance grew to reach 150 million clients worldwide by striving for financial sustainability as the ticket to reaching more people permanently without heavy donor dependence. Most of today’s international microfinance providers believe the poor should be treated as clients, not recipients of charity.
This last point does involve a moral judgment. Is it more moral to help (a few of) the poor through subsidies or to provide (many of) them with services on a business basis? There’s probably a need for each, in different circumstances; the former makes more sense in the U.S., while the latter is an unavoidable necessity in the developing world.
This is just a start. If we can agree on the above, we can start to tackle the hard practical question at the heart of the Smart Campaign: how to determine when a lender is charging too much and what to do about it.