Interest Rates

The Reserve Bank of India (RBI), the country’s central bank, has been steadily increasing its interest rates for the past two years. For microfinance institutions (MFIs), a rising interest rate means they must either absorb the costs themselves or apply these higher rates to their clients. Interest rates are a sensitive topic among microfinance borrowers, and many MFIs have tried to avoid or postpone the day when they will have to raise their own rates. However, with RBI’s most recent increase in interest rates, they may no longer have a choice. The microfinance associate, KAS Foundation, of ICICI Bank, India’s second-largest bank, has just announced that it will increase lending rates, and other institutions look to be on the verge of following suit (see story).

In a paper published by Asian Development Bank (ADB), Nimal A. Fernando offers an explanation into why microcredit interest rates are so high, and what should, and should not be done to address this.  The paper, entitled Understanding and Dealing with High Interest Rates on Microcredit, is addressed toward Asian Policymakers who have become increasingly critical of the high interest rates being charged by microfinance institutions (MFIs). 

Peruvian microfinance institutions (MFIs) EDPYME EDYFICAR and EDPYME Crear Arequipa S.A. received $750,000 and $500,000 loans respectively from the Triodos Fair Share Fund.

The Triodos Fair Share private fund—launched by the Netherlands’ Triodos Bank to invest in MFIs that are at least two years old—had an €8.2 million portfolio at the end of 2004. MIX Market states that the fund’s loans range from $200,000 to 1 million for a period no more than 5 years, and that there are “usually no formal guarantees.” Interest rates on the loans to MFIs “must be sufficient to cover potential devaluation against the Euro plus to cover costs of 8%.”

With total assets of approximately $50.36 million, EDPYME EDYFICAR provides loans to microentrepreneurs on an individual and group basis while EDPYME Crear Arequipa S.A., with assets totaling approximately $12.52 million, only offers individual loans. In 1997, CARE Peru transformed into EDPYME EDYFICAR. The MFI’s loan portfolio grew from $3.835 million in 1998 to $47.2 million in January 2005. Founded by NGO Habitat Arequipa Siglo XXI in 1992, EDPYME Crear Arequipa’s loan portfolio increased from $1.31 million in 1998 to $10.578 million as of January 2005. EDYPME Crear’s loans range from $100 to $10,000 with “terms between 6 and 24 months.”

Additional Resources

1) Consultative Group to Assist the Poor (CGAP): “Microfinance Capital Markets Update” is the best source for monthly updates on debt and equity deals in microfinance.
2) “Funds: Triodos Fair Share Fund.”
3) “Microfinance and Fair Trade: Triodos Fair Share Fund.”
4) MIX Market: “EDPYME EDYFICAR.”
5) MIX Market: “EDPYME Crear Arequipa S.A.”
6) “EDYPME Crear Arequipa: Financial Data.”
7) “EDYPME EDYFICAR: Financial Data.”
8) MIX Market: “Triodos Fair Share Fund: Fund Instruments.”

The Netherlands headquartered Hivos-Triodos Fund (HTF) recently loaned approximately $650,000 to three Latin American microfinance institutions (MFIs). Peruvian MFIs EDPYME Nueva Vision, with a 2004 year end portfolio of about $3.8 million, and EDPYME Crear Tacna, holding 2004 year end total assets of approximately $7.37 million, received $150,000 and $300,000 respectively, while El Salvadorian MFI Sociedad Cooperativa de Ahorro y Credito AMC de R.L (AMC), with total assets in 2004 of approximately $6.45 million, received $200,000. The three MFIs each direct money to micro-businesses in semi-urban and rural areas within their countries.

The Hivos-Triodos Fund, which was formed out of a joint initiative between the Humanist Institute of Development Cooperation (HIVOS) and Triodos Bank, provides loans to MFIs. MIX Market states that the HTF’s loans range from $150,000 to $1 million for a maximum of five years and there are “usually no formal guarantees required.” “Interest rates must be sufficient enough to cover potential devaluation against the Euro plus to cover minimal costs of 8%.” The fund had a 2004 year end portfolio totaling €17 million.

Additional Resources

1) Consultative Group to Assist the Poor (CGAP): “Microfinance Capital Markets Update” is the best source for monthly updates on debt and equity deals in microfinance.
2) “Funds: Latin America—Peru.”
3) “Hivos-Triodos Fund Foundation.”
4) “HTF (The Hivos-Triodos Fund).”
5) MIX Market: “EDPYME Crear Tacna (EDPYME Crear Tacna).”
6) “Sociedad Cooperativa de Ahorro y Credito AMC de R.L.”
7) “Funds: Latin America—El Salvador.”
8) MIX Market: “EDPYME Crear Tacna: Financial Data.”
9) MIX Market: “Cooperativa AMC: Financial Data.”
10) “Hivos-Triodos Fund Foundation: Annual Report 2004.”
11) MIX Market: “Hivos-Triodos Fund: Fund Instruments.”

Close to one billion people are slum dwellers (approximately one-sixth the world population), a number, according to the UN Human Settlements Program (UN-HABITAT) that will increase almost 200% by 2030. This provides an enormous market for housing microloans—a huge source of untapped profits—that could alleviate a future crisis by helping with “slum upgrades and slum prevention.” While state-subsidized housing may also be a solution, immediate massive investment in urban shelter and services should be of primary concern and will require the leadership of the private microfinance sector.

Serving the vast pool of housing microloan borrowers are numerous industry players including “urban developers, regulated financial institutions, government agencies, credit cooperatives, NGOs with an urban poverty focus, and MFIs” who provide the housing loan services.

Though conventional mortgages often remain unattainable for the poor, the merging of such traditional housing finance and microenterprise has enabled poor families to improve their homes by building in stages. About 70% of investment in microfinance housing has in fact been utilized in such “incremental building.” An UN-HABITAT report concludes that smaller short-term loans (microloans less than $5000 for one to eight years) prove more feasible to city dwellers who cannot afford long-term loans “favored by mortgage markets.” Housing Improvement Loan Products designed by Peruvian MFI Mibanco, for instance, allows households to finance home improvement projects instead of completely new construction. Besides small shorter-term loans, housing microloan products also typically have flexible repayment systems and require an established trust between borrower and lender instead of houses for collateral. Interest rates, just lower than microenterprise rates, are also sometimes used. These features have contributed to high repayment rates, enabling MFIs and other housing organizations, to achieve a profit and possibly avert the looming crisis of global slums.

Additional Resources

1) “World Faces Prospect of Teeming Mega-Slums.”
2) Accion InSight #4: “Building the Homes of the Poor—One Brick at a Time, Housing Improvement Lending at Mibanco.”
3) “Helping to Improve Donor Effectiveness in Microfinance—The Impact of Interest Rate Ceilings on Microfinance.”
4) “A New Approach to Low-Income Housing Finance.”
5) “Helping to Improve Donor Effectiveness in Microfinance—Housing Microfinance.”
6) “Developing Housing Microfinance Products in Latin America.”