Why do MFIs charge such high interest rates to poor people?
Providing financial services to poor people is quite expensive, especially in relation to the size of the transactions involved. This is one of the most important reasons why banks don’t make small loans. A $100 dollar loan, for example, requires the same personnel and resources as a $2,000 one thus increasing per unit transaction costs. Loan officers must visit the client’s home or place of work, evaluate creditworthiness on the basis of interviews with the client’s family and references, and in many cases, follow through with visits to reinforce the repayment culture. It can easily cost US$25 to make a microloan. While that might not seem unreasonable in absolute terms, it might represent 25% of the value of the loan amount, and force the institution to charge a “high” rate of interest to cover its cost of loan administration. The microfinance institution could subsidize the loans to make the credit more “affordable” to the poor. Many do. However, the institution then depends on perm
Providing financial services to poor people is expensive. This cost is one of the most important reasons why banks don’t make small loans. For example, a Rs.2000 loan requires the same amount of resources as a Rs.100,000 loan. Microfinance is a high-touch business: At SKS, field staff managers must perform village surveys before entering a village, conduct interviews with potential members, train members on credit discipline, travel to villages by motorbike every week to collect interest and disburse loans, and follow-up to ensure the loans are being used for their intended purpose. These personnel and administration costs easily amount to 11% of our total cost structure. In addition, we must borrow from commercial sources to lend to our members. This cost of lending is anywhere from 10-12%. The combination of this personnel/administration costs, the cost of lending, a 1-2% loan loss provision (due to default or writing off a loan), and 1-2% profit used to expand operations, translates
Concerns often arise as to why microcredit interest rates are higher than the bank interest rates that wealthier people pay. The issue is cost: the administrative cost of making tiny loans is much higher in percentage terms than the cost of making a large loan. It takes a lot less staff time to make a single loan of N100,000 than 1,000 loans of N100 each. Besides loan size, other factors can make microcredit more expensive to deliver. Credit decisions for borrowers who have neither collateral nor a salary cannot be based on automated scoring. These decisions require substantial intervention of a loan officer in judging the risk of each loan.
Providing financial services to poor people is quite expensive, especially in relation to the size of the transactions involved. This is one of the most important reasons why banks don’t make small loans. A TZS 50,000 loan, for example, requires the same personnel and resources as a TZS 2,000,000 one thus increasing per unit transaction costs. Loan officers must visit the client’s home or place of work, evaluate creditworthiness on the basis of interviews with the client’s family and references, and in many cases, follow through with visits to reinforce the repayment culture. It can easily cost TZS 12,500 to make a microloan. This might represent 25% of the value of the loan amount, and force the institution to charge a high rate of interest to cover its cost of loan administration.
Providing financial services to poor people is quite expensive, especially in relation to the size of the transactions involved. This is one of the most important reasons why banks don’t make small loans. A $100 dollar loan, for example, requires the same personnel and resources as a $2,000 one thus increasing per unit transaction costs. Loan officers must visit the client’s home or place of work, evaluate creditworthiness on the basis of interviews with the client’s family and references, and in many cases, follow through with visits to reinforce the repayment culture. It can easily cost US$25 to make a microloan. While that might not seem unreasonable in absolute terms, it might represent 25% of the value of the loan amount, and force the institution to charge a “high” rate of interest to cover its cost of loan administration.
