Paying interest to lenders - pros and cons

[Guest]

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[Ari]

It's my understanding that entrepreneurs pay 15-30% interest depending on the amount of their loan and the MFI servicing them, is that about right?  All of the interest is now paid to the MFI.
What if another 5-10% interest were added, and this paid to the lenders?  In return, entrepreneurs could be given an extra few months to pay off the loan.  Many loans are for $1000 with a repayment term of 8-12 months.  This means the entrepreneur expects to pay back about $100 a month during the loan period.  10% of $1000 is $100, i.e. one more month of repayment.  Would that one extra payment really make that much difference to the entrepreneur?
On the other hand, 10% interest is substantially higher than most banks in the U.S. offer these days.  This could be a huge incentive for new enders and for everyone to lend more.  Since repayments on Kiva have been 100% until now and have been around 96% in microfinance in the past 30 years, lenders have every reason to expect the 10% return, especially with a diverse portfolio (i.e. lending a small amount to many different people).
I'm lucky that here in Iceland, interest rates are quite high - my savings account currently has about 12% interest.  However, if Kiva were to offer 10% interest to lenders, I would have no problem putting a substantial part of my savings into Kiva loans.  In spite of the extra 10% interest, this could be of help to so many more entrepreneurs in the developing world.  I'd much rather help them (and get a 10% return) than put most of my money into a savings account which only makes my bank richer.

[Ari]

I just read on Kiva Chronicles that under U.S. banking law, Kiva is currently not allowed to pay interest to lenders, but is applying to be able to do so.  I'd still like to hear your thoughts on the subject!

[optimistic.bob]

I was trying not to wade in on this discussion which received a number of posts on the Yahoo forum.
If Kiva began to charge market or above lending rates, I would really need to rethink my participation. I have investments that are yeilding significant returns, some as high as 68% in the past year. I have played the market and day traded for a while and had mixed success. I do not invest in small going concerns through Kiva as a venture capitalist to earn interest  but as an act of social responsibility.
I chose Kiva because the organizational business plan was summed up as "The individuals featured on our website are real people who need a loan and waiting for socially-minded individuals like you to lend them money. "

Even though there as been a near perfect repayment record, the risks of micro-lending are very high and if we were to attempt to attract investors with a ROI message the rate might need to reach usury levels. I believe that Kiva's record of attracting new investors and the influx that a small bit of publicity generated should allow Kiva to grow with the passion and vision that Jessica and Matthew started with.

[randulo]

Bob, I totally agree. The whole thing feels different. I hope this doesn't happen as I too would seriously re-think my participation, as crazy as that sounds. It wouldn't seem possible to waive interest if that were an option either, so I guess I'm nuts.

[optimistic.bob]

I am glad Ari raised the topic. For those that are interested Google "micro loansharking". There has been a number of great blog posts and articles on the subject recently.

[Julia]

I'd rather Kiva not pay interest also.  I agree with Bob that they can't really pay enough to make it worthwhile from a monetary investment point of view.

I have marketed Kiva to some of my muslim friends as being ideal for them because they aren't making interest. Apparently many muslims believe it wrong to make interest off money, so they can't keep their money at normal banks.   So Kiva, as it stands, is great for them.

[AGullen]

Ari, I had actually had this same thought a few months back. It seemed like a great idea to tack on an extra few percent on the interest level of the loans to help draw in more lenders, but now I'm not so sure. It doesn't matter if the lender gets a 10% rate of return, or 1%. Interest completely changes the game. People right now are lending because it feels good to them. They are setting aside small portions of their wealth and gaining satisfaction from knowing that they are doing good. When you replace incentives (in this case interest in exchange for a warm fuzzy feeling) the results are often strange. Now seen as an investment vehichle, some people who are already lending might lend less. They are still giving a hand-up to the worlds poor, but the motivation has been changed. I'm sure that in the end more people would end up loaning larger sums of money, but it isn't just a completely positive propisition like it first seemed to be to me. Not to mention what now happens to the 10% donation for overhead that kiva asks for? I find it hard to believe that the lenders will still donate to their own financial organization. So I'm in favor of keeping it the way it is, although there is room in this field for a competitor who utilizes a slightly different format...

[Phil]

I agree with Bob's comment - I lend because I want to help out, not because I want to make money. If I wanted to make money, apparently I should open a savings account in Iceland (12% - that's crazy!! I only get a measly 0.5% at my stupid bank.. which I might add I also work for)

However, some other thoughts I thought I'd throw in:

- adding extra interest to a loan may increase the chance of a default on the loan (bad for the lender AND the borrower)
- adding extra interest to a loan would increase the payback period, meaning that this entrepreneur would not be able to apply for another loan until the first was paid of. This will decrease the overall supply of loans (refer to other post

What other impacts (positive or negative) might additional interest charges result in?

[Ari]

Thanks to all of you for posting.  I'm not in Kiva either to make money, but it's an interesting thought.  Though as you rightly pointed out, there is no shortage of lenders right now, so they don't need to add incentive.
Phil, you can get around 5% with an online HSBC account.  That way you won't be subject to currency risk

[Kevin]

I think 15-30% interest is outrageous, really (even though I understand the economics behind it). I don't think we should ask the borrower to pay more. I would like to know how the microfinancing organizations use these dollars. Also, I would like to know what the transaction costs are. The kiva FAQ page uses a hypothetical figure of $25, but some of the loans in Viet Nam were for only $75 or $100. I'd like to know whether fees are adjusted for real income.