MFI's Extortionate Interest Rates ... up to 58% !

[Guest]

.

[Australia]

It was my own fault. I didn't dig into the background info on the MFIs to whom I made loans and didn't realise I could find the interest rate being charged. When I stumbled on it today (More on this Field Partner link, scroll way down to the bottom) I was more than a little shocked to find:

                                                                                                      This Field Partner  All Kiva Partners
   Average Interest Rate Borrower Pays To Kiva Field Partner     45.00%                  23.17%
   Average Local Money Lender Interest Rate                            120.00%                  86.82%

                                                                                                      This Field Partner   All Kiva Partners
   Average Interest Rate Borrower Pays To Kiva Field Partner     58.00%                  23.17%
   Average Local Money Lender Interest Rate                            120.00%                  86.82%

45% was bad enough on one loan, but 58% on the other! That is just usurious surely? And how could anyone justify subsidising such an MFI's fx losses as well?

I've seen the criticisms of microlending burdening the working poor with debt, but this is macro - not micro - usury. And yes, I've read the explanations about the higher cost of microlending vs 1st world bank rates, but 58% ? There's nothing micro about these loans.

I think Kiva should move this information from where it is currently buried, to the first page which features the borrower. I would certainly avoid all such future loans, and would have avoided these two if I had known.

Have you checked your MFI interest rates lately?

[wthepoo]

Have you checked your MFI interest rates lately?

Yes, as far as they are provided (with quite a number of MFIs they are not - even though Matt promised months ago that Kiva would work on that).

45% was bad enough on one loan, but 58% on the other! That is just usurious surely? And how could anyone justify subsidising such an MFI's fx losses as well?

Just to make sure, I believe you are talking about two of the five Peruvian MFIs - FINCA (45%) and MFP (58%). Arariwa don't provide theirs and EDAPROSPO (54%) and Manuela Ramos (35%) state relatively high interest rates as well.

This in itself and the comparison with the quoted money lender interest rate of 120% might indicate that it isn't really usurious but adequate for the local market and the services the MFIs are providing - of course I cannot really tell, and my first guess that the interest rates might have to do with a particular FX risk or high anticipated inflation seems to be wrong (a quick research indicates that the Nuevo Sol has been relatively stable and that inflation in Peru in recent years was always less than 4%). Thus, I don't really know why the average interest rates of Peruvian MFIs are all (as far as stated) far higher than the Kiva average - it might be worthwhile asking Kiva on their take (perhaps in one of the next KF-Liaison calls, Diane?); which extra services are Peruvian MFIs providing that are worth these rates etc. (insurance, training, counseling, health care...) or why aren't these interest rates adequate and compatible with Kiva's and the Field Partner's mission to alleviate poverty?

I have to admit, though, that these interest rates are one reason why I don't have that many loans in Peru (same goes for Mexico).

Best wishes,
Wolfgang.

[Australia]

Yes, as far as they are provided (with quite a number of MFIs they are not - even though Matt promised months ago that Kiva would work on that).

I hadn't come across any without an interest rate, but I'd be even more suspicious of no rate.

Just to make sure, I believe you are talking about two of the five Peruvian MFIs - FINCA (45%) and MFP (58%). Arariwa don't provide theirs and EDAPROSPO (54%) and Manuela Ramos (35%) state relatively high interest rates as well.

Yes, you're spot on with the 45% and 58% MFIs.

I did note the high "moneylender" rates (which is why I also included them), but like you, I cannot see any obvious reason why the MFI rates are so high and such rates don't seem classifiable as "alleviating poverty".

It also brings to mind one of the other criticisms I've read about microlending: that it does not actually benefit the *very* poor at all as they cannot afford to repay let alone with interest (certainly not at these rates). Perhaps a harvest would bring in enough to pay such a loan off in one hit, but as an ongoing debt burden...

I, and my wife,  found it hard enough together paying a home mortgage rate of 18.5% in the 1980s here in Oz (and really only managed it because I was also getting quarterly pay rises - ahh those halcyon days of yore). I just cannot imagine what 45% or 58% must be like when you're on a more or less fixed income.

[chris]

Note that the interest rate stated is the average annualized rate.  Many of the Peruvian loans tend to have short loan terms; Finca has an average loan term of 5 months, and an average loan size of <$300. I would expect a higher interest rate on small, shorter loans, as the fixed cost of servicing the loan has fewer months to be recouped.  Comparing it to a mortgage isn't really fair, since that is a large, long-term loan with backing collateral.

[Sengbe Pieh]

The following is from the CGAP site.

                                   

Why Do MFIs Charge High Interest Rates?

                                                           

Over the past two decades, institutions that make microloans to low-income borrowers in developing and transition economies have focused increasingly on making their operations financially sustainable by charging interest rates that are high enough to cover all their costs. They argue that this policy will best insure the permanence and expansion of the services they provide. Sustainable (i.e., profitable) microfinance providers can continue to serve their clients without needing ongoing infusions of subsidies, and can fund exponential growth of services for new clients by tapping commercial sources such as deposits from the public.

The problem is that the administrative costs are inevitably higher for tiny microlending than for normal bank lending. Lending out a million dollars in 100,000 loans of $100 each will obviously require a lot more in staff salaries than making a single loan for the total amount. As a result, interest rates in sustainable microfinance institutions (MFIs) are substantially higher than the rates charged on normal bank loans.

There are three kinds of costs the MFI has to cover when it makes microloans. The first two, the cost of the money that it lends and the cost of loan defaults, are proportional to the amount lent. For instance, if the cost paid by the MFI for the money it lends is 10 percent, and it experiences defaults of 1 percent of the amount lent, then these two costs will total $11 for a loan of $100, and $55 for a loan of $500. An interest rate of 11percent of the loan amount thus covers both these costs for either loan.

The third type of cost, transaction costs, is not proportional to the amount lent. The transaction cost of the $500 loan is not much different from the transaction cost of the $100 loan. Both loans require roughly the same amount of staff time for meeting with the borrower to appraise the loan, processing the loan disbursement and repayments, and follow-up monitoring. Suppose that the transaction cost is $25 per loan and that the loans are for one year. To break even on the $500 loan, the MFI would need to collect interest of $50 + 5 + $25 = $80, which represents an annual interest rate of 16 percent. To break even on the $100 loan, the MFI would need to collect interest of $10 + 1 + $25 = $36, which is an interest rate of 36 percent.*

MFIs have to charge rates that are higher than normal banking rates to cover their costs and keep the service available. But even these rates are far below what poor people routinely pay to village money-lenders and other informal sources, whose percentage interest rates routinely rise into the hundreds and even the thousands.

This does not mean that all high interest charges by MFIs are justifiable. Sometimes MFIs are not aggressive enough in containing transaction costs. The result is that they pass on unnecessarily high transaction costs to their borrowers. Sustainability should be pursued by cutting costs as much as possible, not just by raising interest rates to whatever the market will bear.

Interest rates, while still too high in some places, are dropping on average 2.3 percent a year. The microfinance industry has placed a lot of emphasis on improving efficiency in order to bring down these costs, so that poor clients are not paying unnecessarily high rates. New technology also offers to help reduce costs, so we expect rates to continue dropping as institutions become increasingly efficient at delivering services to poor people.

CGAP research found:
- MFI interest rates averaged about 28 percent in 2006, declining by 2.3 percent a year since 2003.
- MFI rates are lower than consumer and credit card rates in most countries, and usually far lower than rates charged by informal moneylenders.
- At an average 12.7 percent of portfolio in 2006, operating costs are the largest single contributor to interest rates, declining by one percentage point per year since 2003.
- MFIs on average have higher returns on assets than commercial banks, but produce lower returns on equity for their investors. At the same time, the most profitable 10 percent of MFIs were producing returns on equity above 34 percent in 2006. Some of these profits are captured in private pockets.

http://www.cgap.org/p/site/c/template.rc/1.26.1309/

                                                                                                                                                             

* These rates are based on a loan term of one year. On loans of 6 months or less, the annualized rate will be proportionately higher.

http://www.cgap.org/p/site/c/

[Unilove]

Thank you for the very detailed, thoughtful responses...  Good information, all...

[hejustlaughs]

It's not usurious in that these MFIs aren't making money hand over fist on these loans. The interest rates charged are considerably lower than the local moneylender rate AND the goal of the MFI is to be self-sustaining, not a charity.

[wthepoo]

Note that the interest rate stated is the average annualized rate.  Many of the Peruvian loans tend to have short loan terms; Finca has an average loan term of 5 months, and an average loan size of <$300. I would expect a higher interest rate on small, shorter loans, as the fixed cost of servicing the loan has fewer months to be recouped. (...)

Thanks, Chris, for remindung us of that. I forgot to check average loan sizes and terms yesterday, and it turns out that average terms for the four MFIs are considerably shorter than the Kiva average, and that average loan sizes are smaller or about the same as the Kiva average. This indeed has to considerably influence the interest rates.

Kiva averages:        $422 for 9.69 months
FINCA:                   $286 for 4.29 months
MFP:                     $464 for 6.27 months
EDAPROSPO:           $382 for 5.17 months
Manuela Ramos:       $471 for 4.81 months

Best wishes,
Wolfgang.

[Australia]

No - sorry - I don't buy the CGAP site explanation for a rate of 58%. That site is not justifying such usurious rates anyway. There is a difference between charging "high" interest rates and "usurious" interest rates.

Pointing out that the Merchants of Venice charge higher rates is quite specious. They charge what the market will bear to those who do not otherwise qualify for loans.

A little research at the Central Reserve Bank of Peru finds that in its March 2009 Report, the Bank states that:

69.The other interest rates on active operations increased: the rates on commercial
     loans increased from 10.5 to 10.9 percent in the same period, while the rates
     on consumer loans and on loans to micro businesses increased from 31.8 to 32.8
     percent and from 35.0 to 35.5 percent, respectively. This was mainly associated
     with banks' higher financing costs and with a higher perception of credit risk in the
     context of the international financial crisis.

The core Peruvian inflation rate is 5.69% (the 12 month rate is 4.78% and 2.85% ex food and beverages).

As of April 22, the exchange rate against the $US had declined 10.63% over the last year (better than the $A which has declined 25% in the same period :-).

Peruvian Banks loan to micro businesses at a rate of 35.5%.

It doesn't look to me like a Peruvian MFI, which obtains its Kiva funds at a maximum cost of 10% (annual FX $US hedge), is passing any saving on to its borrowers at a rate of 58%.

[redstarr]

I've noticed that compared to the average local lender's rates, the Kiva MFI's rates are a LOT lower.  That's great.  The people borrowing from the MFIs are getting a much better deal than if they were to try and take the loan out from the local banks (or sharks). 

And I'm thinking that while the rate is a bit high, the access to credit at all is a great thing.  Most of the borrowers don't qualify for "regular' loans from regular banks.  Banks aren't going to deal with the impoverished, the folks that need a couple hundred bucks, etc.  They are in the business of lending bigger amounts to bigger business with credit ratings and such.  The old vicous cycle of having to have money to borrow money.  The folks that a loan would do the most good aren't able to get one. 

Plus, in a lot of countries,the MFIs are willing to lend to women, while the traditional lenders are not.  Places like Tanzania, women don't have the same property rights and financial rights as men, so the banks won't lend to them at all, but the MFIs do.  So while it's a higher rate than a man would pay at a regular bank, for a Tanzanian woman, even the  higher rate loan offers an opportunity that she would have not been offered at all at any rate elsewhere.

And if the person's business succeeds and grows and they prove their credit worthiness either through the assets and track record of their business itself or through their history of being good borrowers from the MFI, they can improve their access to "regular" banking channels.  While they're starting or growing their business through money from an MFI, the rate may be a bit high, but eventually it'll help them establish themselves enough to get a much lower, more acceptable by American standards, type rate at a regular bank.