Usurious Rates in Microcredit and Microfinance Abound – A Thanksgiving Message on Righteous Investing - MicroCapital: On Microfinance and Microcredit Investment

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Wednesday, November 23. 2005

Usurious Rates in Microcredit and Microfinance Abound – A Thanksgiving Message on Righteous Investing

Microfinance and microcredit are wrought with usury. At the Global Microentrepreneurship Awards, Bangladeshi Finance and Planning Minister M. Saifur Rahman criticized microlenders for charging rates almost three times as much as the rates on loans microlenders receive from commercial banks.

Mr. Rahman did not dare utter the dirty little word “usury”—defined as—an exorbitant or unlawful rate of interest, but those of us committed to “poverty eradication through profits” must not shy away from naming the evil. Mr. Rahman describes the situation in

Bangladesh

where micro-banks take out loans with 8-9% interest from commercial banks and subsequently charge as much as 22% interest on loans to microentrepreneurs. But, this is just the tip of the iceberg.

Bangladesh is one of the most mature microcredit markets in the world. The spread and dynamic described by Mr. Rahman pales compared to the usurious atrocities that occur everyday in the global microfinance industry. Imagine this scenario:

Your tax or charitable dollars are DONATED by an inexperienced bureaucrat or do-gooder to a micro-bank that in turn lends to a poor borrower at a real annual rate of 60-120%. Moreover, the real rate of interest is deceptively hidden from the borrower. Although hard to swallow, this scenario is common. You are funding it. The usurious road is paved with good intentions.

Higher repayment rates from micro borrowers have, thankfully, attracted commercial lenders who see substantial growth opportunities in a new market. While increasing commercialization brings more lenders and borrowers together, the trade-off is also an increasing number of vulnerable borrowers who are falling prey to abusive lenders.

So, ironically, the Bangladeshi situation demonized by Mr. Rahman actually represents the solution, not the problem. At the very least, the situation he describes enforces fiscal accountability upon the intermediary micro-bank via the loan contract with the commercial bank. Typical of ill-informed government functionaries, Mr. Rahman seeks popular approval by legislating usury in microfinance. This is wrong. To read about what Mr. Rahman should do, please see the following entries on regulation and right action by governments and charities posited by Jean-Philippe De Schrevel of BlueOrchard Finance.

Bangladesh may actually be on the cusp of greatness. While Mr. Rahman may consider 22% too expensive, the fact that extremely poor people literally living above open sewers now have the option to be customers of responsible financial institutions that provide essential services like savings, insurance, and mortgages is no small achievement. A mere decade ago, the option was hardcore usury by the guy known for breaking knees. Sadly,

Bangladesh microfinance

is far more advanced than most of the developing world where irresponsible, often usurious micro-lending is the rule, not the exception.

How will we stop usury? This is a noble question as we sit down to give thanks for our blessings. Establish a secure investment class in microfinance to bring down the price of capital and drive the evil-doers out of business. This we will do.

Additional Resources

1) Main article discussed in entry, The Financial Express: “Large NGOs Becoming Rockefellers.”
2) “Usury.”
3) MicroCapital Blog: “Current Trends in Microfinance: The Growth of Commercial Microfinance.”
4) Consultative Group to Assist the Poor (CGAP): “Protecting Microfinance Borrowers.”

Posted by microcapital in An Emerging Asset Class?, How Important is Microfinance Regulation to Investment Decisions?, Interest Rates, Trends/Challenges at 17:34 | Comments (2)

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I don't think that anyone in the industry actually wants usurious interest rates. However, I'm surprised that your post doesn't at least address the fact that the cost structure for most MFIs are significantly higher than that of their more commercial lenders. With frequent (weekly) borrower meetings, low average loan balances, and minimal MIS integration, the cost structure as it currently stands is bound to require higher interest rates. That said, most in the industry are here because they truly want to help alleviate poverty by giving people the tools (credit and other financial services) that they need to empower themselves based on their own efforts. We've just posted a very high-level post on this same topic -- it doesn't go into a lot of detail, but at least gives some of the cost-side of the equation:

http://blog.unitus.com/?p=33

Thanks for the post and blog -- you've done a great job thus far!

David

#1 David Schappell (Homepage) on 2005-11-24 01:00

Yes, many readers commented on the cost side of the equation. One reader presented the perspective of a microfinance institution (MFI):

“Banks and [microfinance investment] funds like Blue Orchard and MircoInvest are promising their investors big returns to attract capital and compensate for the risk. The poor MFI is forced to charge above 22% to cover its costs (mainly due to overhead inefficiency). Look at 22% - about 10% goes to the funders, MFI overhead definitely is over 10% of assets, most likely about 25%, that's why you have to charge so much to stay alive. There's no margin. Everything has to be squeezed out of overhead (keep it under 10%), and have a high degree of free/equity capital to be sustainable.”

#2 microcapital (Homepage) on 2005-11-28 10:33

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