Interest rates

[Guest]

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[Ashley]

I'm pretty new to all this, so first of all I'd like to say hello! I seem to be catching the bug as I visited Kiva to have a quick look at the current businesses in need and ended up reading virtually all of them and a whole load more information on the site too! That was over 2 hours ago now 

Anyway, on with the post. While reading through the 'help' section, I was reminded that the Field Partners do charge interest on the loans. While it was reassuring to read that 'Kiva.org will not partner with an organization that charges exorbitant interest rates', I thought I would have a look through some of the charges anyway, more out of curiosity than anything else. I have to admit that I was a little taken aback by some of the charges. While many microfinance institutions' average charges are below 10%, there are some that are considerably higher. Admic Nacional for example, has an average interest rate of 54%. Now to me that does not fit too well with the above quote taken from the Kiva website.

I am very interested to hear what other people think of this - I hope that one of you Kiva junkies out there may be able to explain the reasons that may be behind some of the higher rates, particularly this one. Does anyone know if there is a specific rate beyond which is considered 'exorbitant'?

Right now I am leaning toward steering well clear of the Field Partners with the highest rates and I don't mind admiting that discovering this has shaken my confidence in Kiva a little - someone help me get it back! 

Thanks!

[chris]

The microfinance institutions (MFIs) that Kiva works with are self-sustaining businesses.  They need to make money to continue running, and interest is how these lenders do it.  The first thing to realize is that their rates are comparitively low to local loan sharks.  The rates are higher than in the States or the UK for several reasons.  One is that the currencies of emerging markets face much higer inflation rates than the USD or GBP do, so the MFI would actually be losing money if they charged an interest rate lower than the inflation rate.  Another is that the MFIs need to get the cash to loan from somewhere; they don't have access to deposits like large banks do, so the MFI might need to borrow at a market interest rate, and then have to mark it up over that.  Money from Kiva loaners is "free money" for them, but not all the money that MFIs loan out comes from Kiva.  Hopefully, the low rate from Kiva averages against the higher rates of other credit sources, and the MFI can afford to lower the interest rate for their loans overall.

There was a radio interview that I listened to when I first signed up with Kiva; it gives a good view of the microfinance world, with a lot of emphasis on interest rates (toward the end).  Matt from Kiva is on there too:

http://www.kuow.org/mp3high/m3u/WeekdayA/weekdaya20060717.m3u

[AccountAbility]

The other aspect of interest rates has to do with the mathematics of converting a flat fee to an interest rate. In industrialized countries, APRs are thrown around and used as absolute comparisons.  But the truth is it costs a certain amount to originate a loan, particularly where lower volumes are the rule and inefficiencies abound because of communication and transportation difficulties.  So let's just take a simple example.  Let's say it cost $50 to originate a loan.  If that loan is for $10,000 and lasts for 5 years (like an auto loan for instance).  The origination adds .1% (one tenth of one percent) to the carrying interest rate, e.g. 8.0% becomes 8.1%.  So we dismiss it.  But apply the same math to a $500 loan that will be repaid in 6 months.  The origination of $50 will add 20% to the base interest rate.  So even if Kiva loans are provided interest free, the origination in this example would require the MFI to charge 20% just to break even.
The truth is that many of these MFIs are breaking new ground in areas where the origination will cost much more, because lending to new borrowers here involves a degree of training and "hand-holding" which western lenders are seldom called upon to provide as part of the loan process.

[Ashley]

Thanks folks, that is just what I wanted to hear.

It turned out my confidence wasn't shaken so bad after all, as within 30 minutes of finishing the post I'd made two new loans! 

[RichardF]

Okay, here's the filp side to that question.

For an origination cost of $50...
Average Kiva loan:  $667.38
Average Loan Term (months): 9.69
APR: 9% (a guess at the math, but should be in the ballpark)

Many MFIs, such as Adelante Foundation, appear to be charging considerably less than the cost of originating a loan.  This does not even take into account any income they would make on the loan.

So, how do "below cost" MFI interest rates support the concept of sustainable development?  If the MFIs are, in fact, being subsidized in order to offer these below cost loans, then their business model very well may not be sustainable and will not be a viable long term solution.  I would like to know Kiva's thinking on this aspect of some of their MFI's interest rates.

[cpbailey]

Excellent coverage on interest rates and costs to originate loans.  One additional minor point is that most countries have to contend with flexuations in exchange rates.  They borrow dollars, loan local currency and get repaid local currency and then must repay six months or 18 months later in DOLLARS.  If the dollar gets stronger during the loan term, then it costs the partner in exchange rates. 

Ecuador is based on US dollars, so exchange rate risk isn't a factor for them.

I believe that KIVA considers the partner interest rate vs. other available loan rates.  So if the loan shark rate is 80%, then 20% is a deal!  I figure if someone is making a go at the higher interest rate, then they will be grateful for the lower one and NOT want to lose that opportunity.  They have strong motivation to pay off the loan (and early if possible).  I wonder how the payoff rates compare for low interest partners vs. higher interest partners (on time, early payoff, and so on).

I had an econ instructor in the early '80's who spoke about the then 20% interest rates in the US.  He said that if you could make 40% on a business, then 20% was a good deal.  I think you better know what you are doing, but I guess fewer people were willing to try under 20%--less competition.

[michael]

I believe that KIVA considers the partner interest rate vs. other available loan rates. 

Here is a direct example:

http://www.kiva.org/app.php?page=about&action=aboutPartner&id=20 is the Kiva link for LAPO in Nigeria.  According to the web page, LAPO charges 24% APR.  But the local Buzzard Rate is a crushing 120% per year.  Kiva-MFI-wide, the average rate is 14% APR versus 76% on the street.  Hope this helps.

[AccountAbility]

I mentioned this in one of the other threads, but for centuries usury was considered a bad thing.  It wasn't until the last few centuries where the understanding grew that "capital" can be productive in itself.  If this is so, then charging interest for its use becomes acceptable.  The "bad" would be charging an unreasonable rate.  But reasonable included an expanding list of factors, with different results for different places and economies. 

The new data on partners which includes their average rate compared to the "sharks" (who by definition must be charging the "bad" rate) helps somewhat.  But there are many other factors, some applicable to the region (such as inflation, exchange rates, alternate investment rates) and some applicable to the borrower (principally what productive endeavor will the borrow put this capital into).  As someone previously mentioned, a 20% loan is a good deal to obtain capital which can earn 40% in his or her business.

[michael]

As someone previously mentioned, a 20% loan is a good deal to obtain capital which can earn 40% in his or her business.

Exactly.  Or the aptly named Michael Corellary to that theorem:  "Money that I loan to an MFI for 0% that he lends out for 20% is better than diverting the same cash to Mrs. Michael's next outlet mall spree."


But that's just my opinion.   

[Spartan]

Interesting discussion. It would be interesting to see a rate comparison chart for all field partners, the inflation rate and the best guesses for the local sharks.