Manila, June 9, 2006 AEST (ABN Newswire) - The key to reducing interest rates on microcredit in a sustainable manner is to cut costs through improved market competition, innovation, and efficiency, says a new Asian Development Bank (ASX: ATB) paper.
"Interest rate ceilings are not an appropriate intervention, and there are no quick solutions or shortcuts," says Understanding and Dealing with High Interest Rates on Microcredit, written by Nimal A. Fernando, ADB Principal Microfinance Specialist.
The paper was published in view of policymakers in the Asia and Pacific region becoming increasingly critical of high interest rates charged by microfinance institutions (MFIs), and of some countries moving to impose ceilings on these interest rates.
"ADB hopes that the paper will help policymakers gain a deeper understanding of the issues surrounding microcredit interest rates," says Satish Rao, Director General of ADB's East Asia Department, in his Foreword.
"This understanding will hopefully further enable them to pursue measures that would ensure both the continued growth of the microfinance industry and the enhanced access of poor people to affordable microcredit."
In the paper, Mr. Fernando explains that interest charged on loans is the main source of income for MFIs. Yet in order to survive in the marketplace, MFIs, just like any other business, need to charge prices high enough to cover costs. Thus, because microlending remains a high-cost operation, microcredit interest rates are high.
According to him, the nominal interest rates charged by most MFIs in the region range from 30% to 70% a year (on a reducing balance basis). The effective interest rates are even higher because of commissions and fees charged by MFIs. Other factors - such as the compulsory deposits for obtaining a loan, frequency of repayments, and the systems adopted to collect repayments - also raise the effective interest rates.
"Many MFIs in the region have thus adopted cost recovery interest rates on microcredit. A significant number of such institutions have been able to expand the depth and breadth of their operations," writes Mr. Fernando.
Even with concessional funds, MFIs must cost these at market rates when they make decisions about interest rates to ensure the sustainability of their operations because concessional funds cannot be considered a permanent source of funds.
The paper goes on to say that microcredit interest rates should not be compared with those charged by both commercial banks and excessively subsidized lending organizations. Commercial banks, for example, most often deal with large loans, and their transaction costs are lower than those of MFIs on a per unit basis, allowing them to charge lower interest rates than MFIs.
However, the paper recognizes the importance of lowering microcredit interest rates. Because of their high cost, the paper explains, microcredit has not reached a majority of the poorest people and is not widely used for financing farming activities. "Lower microcredit interest rates will help increase the depth and breadth of availability of affordable finance for poor households," the paper says.
Still, the paper argues that price ceilings are not the answer. Lenders, Mr. Fernando explains in the paper, will incur losses if a rate ceiling is set at a level less than that required for cost recovery. This will reduce an MFI's willingness and ability to expand operations, and discourage potential investors from supporting the industry. Rate ceilings will also reduce the creditworthiness of MFIs, reducing their ability to borrow from the market to finance their operations, and prompting a decline in the supply of credit, contrary to expectations of policymakers who seek such a ceiling.
"Rate ceilings will retard the growth of the MFI industry and result in reducing the supply of microcredit and other financial services, harming rather than helping poor and low income households," the paper says.
Instead, the paper recommends that policymakers seek measures to reduce microcredit interest rates in a sustainable manner, such as promoting an enabling environment for MFIs, encouraging the entry of different kinds of institutions into the industry, and laying the foundations for more competitive markets.
"Some countries in the region are already showing encouraging results from their efforts to create a more competitive environment for the microfinance industry," the paper says. "These measures have resulted in a more competitive industry that, in turn, has led to lower microcredit interest rates."
Contact
Graham Dwyer
Email: gdwyer@adb.org
Tel:+632 632 5253; +632 898 3413; +63 915 741 4363
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