Microfinance

The Impact and Outreach of Microfinance Institutions:
The Effect of Interest Rates
by
Sebastian Schwiecker
(sebastian.schwiecker {at} helpedia {dot} org)
www.helpedia.org
Revised November 2004
This paper was originally submitted in part fulfilment of the requirements for the degree of
Diplom-Volkswirt (German equivalent to Master in Economics) from the University of
Tübingen in October 2004.
Contents
Contents........................................................................................................ 1
Figures .......................................................................................................... 3
Acronyms ..................................................................................................... 4
1. Introduction ............................................................................................. 5
2. The Development of Microfinance ........................................................ 7

2.1. What is Microfinance? ....................................................................................................................7
2.2. The Origin of Microfinance ............................................................................................................8
2.3. Microfinance after the Second World War.....................................................................................9
2.4. Microfinance Today.......................................................................................................................11
3. The Impact of Microcredit ................................................................... 13

3.2. The Eradication of extreme Poverty and Hunger.........................................................................13
3.3. Achievement of universal primary Education ..............................................................................15
3.4. Promote gender Equality and empower Women...........................................................................16
3.5. Reduce Child Mortality and improve Maternal Health................................................................17
3.6. Combat HIV/AIDS, Malaria and other diseases ..........................................................................18
3.7. Ensure environmental Sustainability............................................................................................20
3.8. Develop a global Partnership for Development ............................................................................21
4. Microcredit Outreach ........................................................................... 24

4.1. The Demand for Microcredit.........................................................................................................24
4.2. The Supply of Microcredit .............................................................................................................25
4.3. Meeting the Demand......................................................................................................................26
4.4. Microfinance and the Capital Markets .........................................................................................29
5. Credit Rationing.................................................................................... 31
5.1. The imperfect Information Paradigm ...........................................................................................31
5.2. Adaptation to the Microfinance Sector .........................................................................................33
5.3. Overcoming Credit Rationing for the Microfinance Sector .........................................................35
6. Interest Rates ......................................................................................... 41

6.1. Setting the right Interest Rate........................................................................................................41
6.2. Can Micro-Entrepreneurs bear these Rates..................................................................................43
6.3. Should the Interest Rate be subsidized anyway ............................................................................44
7. Empirical verification ........................................................................... 46

7.1. Setting up a Sample .......................................................................................................................46
1
7.2. Examining the Sample...................................................................................................................47
8. Conclusions ............................................................................................ 52
Appendix .................................................................................................... 54
Appendix 1: Average loan balance.......................................................................................................54
Appendix 2: Portfolio at Risk ...............................................................................................................56
Appendix 3: Transaction Costs ............................................................................................................58
Appendix 4: Portfolio Growth ..............................................................................................................60
Appendix 5: Portfolio vs. Equity ..........................................................................................................60
Appendix 6: Internal Rate of Return ...................................................................................................61
Appendix 7: Subsidized Interest Rates and the Net Gains to Society..................................................62
Appendix 8: Interest Rate vs. Loan Size vs. FSS vs. PAR. ..................................................................63
Appendix 9: Inflation vs. GDP per Capita ...........................................................................................65
References .................................................................................................. 67
Internet References ................................................................................... 71
Ratings........................................................................................................ 76
Other Sources ............................................................................................ 78
2
Figures
Figure 1: Expected Bank Return and the Interest Rate ........................................... 32

Figure 2: The extended Model..................................................................................... 34
Figure 3: Marginal Productivity of Capital ............................................................... 36
Figure 4: The extended Model..................................................................................... 39
Figure 5: Loan Size vs. Interest Rate.......................................................................... 48
Figure 6: Interest Rate vs. PAR .................................................................................. 49
Figure 7.: Interest Rate vs. FSS................................................................................... 50
3
Acronyms
BDB Bank Dagan Bali
BRAC Bangladesh Rural Advancement Committee
BRI Bank Rakyat Indonesia
CF Cost of Funds
CGAP Consultative Group to Assist the Poor(est)
FSS Financial Self-Sufficiency
GDP Gross Domestic Product
GNP Gross National Product
I Interest Rate
IADB Inter-American Development Bank
II Investment Income
IMI Internationale Mikro Investitionen Aktiengesellschaft
IPCC Intergovernmental Panel on Climate Change
K Capitalization Rate
LL Loan Loss
MBB MikroBanking Bulletin
MDG Millennium Development Goal
MFI Microfinance Institution
NGO Non Governmental Organization
NGS Net Gains to Society
PAR Portfolio at Risk
TA Transaction Costs
UN United Nations
USA United States of America
4
1. Introduction
"The poor stay poor, not because they are lazy but because they have no access to
capital."1 If this claim made by nobel laureate Milton Friedman actually holds will be
discussed in the initial part of this paper.
First a short overview of the development of the microfinance sector will be given,
showing that the concept of providing financial services to low income people is much
older than still believed by many development practitioners and bankers around the
world. This is important since it underlines the contribution that microfinance
institutions (MFIs) can make to the development of the financial sector in their
respective countries. Subsequently the various ways how such services can assist low
income people will be discussed demonstrating that even the poorest can benefit from
the provision of small loans. This is a view that is still questioned in the academia.
In the second part of this paper it will be shown that although some 10,000
organizations are involved in microfinance already,2 they are not even close to meet the
tremendous demand for low scale financial services. This sector is still widely neglected
by for profit investors and traditional bankers. After examining why these groups
continue to avoid investments in the microfinance industry it will be checked if the
assumptions that underline their arguments actually hold. The possibility if MFIs could
raise their interest rates to an extend that would allow them generate profits sufficiently
high to attract for profit investors will be discussed.
According to Hulme and Mosley MFIs “can either go for growth and put their resources
into underpinning the success of established and rapidly growing institutions, or go for
poverty impact . . . and put their resources into poverty-focused operations with a higher
risk of failure and a lower expected return”.3 If this is true will be examined in the third
part by checking if poor borrowers are able to bear interest rates significantly above
1
See Friedman (n.d.).
2
See BlueOrchard (2004a).
3
See Hulme and Mosley (1996), p. 206.
5
those charged by conventional banks. Finally a sample of 39 MFIs will be used to verify
the drawn conclusions, by examining the effects their interest rates have on their
financial performances and their repayment record.
6
2. The Development of Microfinance
2.1. What is Microfinance?
According to the Journal of Microfinance the term defines what “is arguably the most
innovative strategy to address the problems of global poverty“.4 This view is shared by
the United Nations (UN) which declared that the year 2005 would be the international
year of microcredit,5 while their General Secretary Kofi Annan stated in 2002, that
“[m]icrocredit is a critical anti-poverty tool and a wise investment in human capital.”6
Hossain describes microfinance as “the practice of offering small, collateral free loans
to members of cooperatives who otherwise would not have access to the capital
necessary to begin a small business or other income generating activities.”7 This view is
to narrow, since it not only excludes such services as saving accounts and insurances,8
but also ignores the possibility of collateral demanding MFIs. Although it is true that
many MFIs do not take collateral, especially if they are focusing on the poorest which
normally do not possess any collateral,9 several MFIs in fact do require some form of
collateral.10
Roth and Steinwand give a more general definition. They describe microfinance as “the
provision of a wide range of financial services like saving accounts, loans, payment
services and insurances for people with no regular access to financial services through
traditional financial institutions.”11 Here it is important not to confuse the terms
traditional or conventional with the term formal. If, for example, an illiterate beggar
takes a $10 loan from the Grameen Bank in Bangladesh she becomes a client of a
4
See Woodworth and Woller, (1999), p. 6.
5
See United Nations (1999), p. 1.
6
Annan (2002).
7
Hossain (2004).
8
See The Microfinance Gateway (n.d); Robinson (2001), p.9; Otero (1999), p. 8.
9
See chapter 3 for a more detailed discussion on poverty.
10
See Robinson 2002, p. 243.
11
See Roth and Steinwand (2004), p. 2 “die Bereitstellung einer breiten Palette von
Finanzdiensteistungen wie Spareinlagen, Kredite, Zahlungsverkehr und Versicherungsleistungen für
Wirtschaftsakteure, die keinen regelmäßigen Zugang zu Finanzdienstleistungen durch klassische
Finanzinstitutionen haben“.
7
formal financial institution (a registered bank), but obviously not of a traditional or
conventional one.12
Although the other services have become more important in recent years, microcredit is
still considered their central service by most MFIs. In many countries it refers to loans
below $ 1,000,13 however for significant cross country comparison it is more
meaningful to look at the ratio of the loan amount to the gross national product (GNP)
or gross domestic product (GDP) per capita for the respective countries. While a loan of
$1,000 is more than four times larger than the GNP per capita in Uganda, it represents
less than 20% of the GNP per capita in Mexico. The MicroBanking Bulletin (MBB) has
categorized the target market for MFIs by the average outstanding loan amount as a
percentage of the GNP per capita ranging from Low-end (less than 20%) to Small
Business (more than 250%).14 Especially for the latter category one must to look closely
at the condition of the financial service market where an institution is active. Although
MFIs exist in industrialized countries,15 one would definitely turn to a traditional
financial institution for a loan bigger than 250% of the GNP per capita and therefore not
to a MFI according to the definition presented above.
2.2. The Origin of Microfinance
Although neither of the terms microcredit or microfinance were used in the academic
literature nor by development aid practitioners before the 1980s or 1990s,16
respectively, the concept of providing financial services to low income people is much
older.
While the emergence of informal financial institutions in Nigeria dates back to the 15th
century,17 they were first established in Europe during the 18th century as a response to
the enormous increase in poverty since the end of the extended European wars (1618 –
12
See Yunus (2002), p. 19 for a more detailed description of the destitute member program of the
Grameen Bank which focuses exclusively on persons with no regular income and no assets at all.
13
See MicroBanking Bulletin (1997), p. 6.
14
15
See Yunus (1998a), pp. 229 et sqq.
16
See Robinson (2001), p. XXX.
17
See Seibel (2003a), p. 12.
8
1648).18 In 1720 the first loan fund targeting poor people was founded in Ireland by the
author Jonathan Swift.19 After a special law was passed in 1823, which allowed charity
institutions to become formal financial intermediaries a loan fund board was established
in 1836 and a big boom was initiated. Their outreach peaked just before the government
introduced a cap on interest rates in 1843. At this time, they provided financial services
to almost 20% of Irish households.20
The credit cooperatives21 created in Germany in 1847 by Friedrich Wilhelm Raiffeisen

served 1.4 million people by 1910.22 He stated that the main objectives of these
cooperatives “should be to control the use made of money for economic improvements,
and to improve the moral and physical values of people and also, their will to act by
themselves.”23
In the 1880s the British controlled government of Madras in South India, tried to use the
German experience to address poverty which resulted in more than nine million poor
Indians belonging to credit cooperatives by 1946.24 During this same time the Dutch
colonial administrators constructed a cooperative rural banking system in Indonesia
based on the Raiffeisen model25 which eventually became Bank Rakyat Indonesia
(BRI), now known as the largest MFI in the world.26
2.3. Microfinance after the Second World War
Because of further prudential regulation and effective supervision, e.g. through bank
superintendencies, the banking sector in the now developed world experienced
continuous growth. Today the vast majority of the citizens of the industrialized
countries have access to financial services with many of them being customers of
former MFIs.27
18
See Steinwand (2001), p. 51.
19
See Robinson (2002), p. 96.
20
21
first known as Darlehnsvereine and now called Raiffeisenbanken
22
See Morduch (1999a), p. 1573.
23
Raiffeisen (1966), quoted in Richardson (2000), p. 3.
24
25
26
See Roth, Steinwand (2004), p. 3.
27
9
This is not true for most developing countries where market penetration of financial
institutions is far from reaching the majority of the inhabitants (see chapter 4). A variety
of reasons is responsible for this, including that the banking sector in the most
developing countries have developed in a very different way to than those in
industrialized countries.
One of the most important reasons is that, in contrast to the industrialized countries little
attention has been paid to the legal recognition, prudential regulation and effective
supervision of informal financial institutions.28 This insecure legal environment leads to
several problems. Since the regulatory framework for mobilizing savings often does not
fit the needs of institutions targeting low income people, many organizations are not
permitted to do so and are therefore missing funds to on-lend as credit.29 An additional
problem is the lack of a deposit insurances. This not only increases the risk of a bank
run, but also keeps people from depositing their savings in a financial institution.30 In
addition, inappropriate interest rate ceilings prevail in many countries. While politics
claim they are lowering the interest rates charged to the poor, they de facto only limit
their access to financial services (see chapter 5).31
Another problem that retarded the growth of the financial sector in developing countries
was the supply-leading finance theory which dominated the development strategies of
many countries after the second world war.32 This theory “ refers to the provision of
loans in advance of the demand for credit, for the purpose of inducing economic
growth.”33 Since it was believed that poor people were neither able to save (and thus
dependent on outside funding), nor capable of paying commercial rates of interest,
massive subsidized credit programs were established.34 The results were alarming.
Repayment rates often did not exceed 50 percent and some government financed
programs even had default rates of more than 90 percent.35 The main reason being that
credit was not provided according to business management principles but instead
28
See Seibel (1998), p. 8.
29
30
See Staschen (1999), p. 14.
31
See Gibbons (2000), p. 15.
32
33
Robinson (2001), p. 140.
34
See Borst (2004), pp. 33 et sqq.
35
See Yunus (1998a), p. 154; Robinson (2001), p. 145.
10
according to political objectives. Therefore receiving loans was seen as a reward for the
constituents rather than as a business transaction. Most of the funds earmarked for the
poor also never reached them ending up instead in the hands of the local elites.
Attracted by the below market interest rates and the possibility not to pay back at all,
these groups lobbied to be treated privileged and often used the money received for
consumption or for on-lending at higher rates.36 But subsidized credit not only
encouraged corruption, it also discouraged sustainable financial institutions, since they
could not compete with interest rates that were not aimed to cover all costs and were
sometimes even lower than the interest paid on savings.37 The low or negative spread
also worked as a negative incentive to institutions’ effort to mobilize savings which in
turn intensified the problem of credit rationing (see chapter 5).
2.4. Microfinance Today
In the 1970s a paradigm shift started to take place. The failure of subsidized government
or donor driven institutions to meet the demand for financial services in developing
countries let to several new approaches. Some of the most prominent ones are presented
below.
Bank Dagan Bali (BDB) was established in September 1970 to serve low income people
in Indonesia without any subsidies and is now “well-known as the earliest bank to
institute commercial microfinance”.38 While this is not true with regard to the
achievements made in Europe during the 19th century, it still can be seen as a turning
point with an ever increasing impact on the view of politicians and development aid
practitioners throughout the world. In 1973 ACCION International, a United States of
America (USA) based non governmental organization (NGO) disbursed its first loan in
Brazil39 and in 1974 Professor Muhammad Yunus started what later became known as
the Grameen Bank by lending a total of $27 to 42 people in Bangladesh.40 One year
later the Self-Employed Women’s Association started to provide loans of about $1.5 to
36
See Robinson (2001), pp. 144 et sqq.
37
Before BRI underwent a major transformation in 1983 a negative spread between interest rates on loans
and savings existed. While the bank lent at a 12% annual effective interest rate, it paid 15% on savings.
38
Wardhana (2001), p. XXVII.
39
See ACCION (n.d.).
40
See Yunus (1998a), p. 16 et sqq.
11
poor women in India.41 Although the latter examples still were subsidized projects, they
used a more business oriented approach and showed the world that poor people can be
good credit risks with repayment rates exceeding 95%,42 even if the interest rate charged
is higher than that of traditional banks. Another milestone was the transformation of
BRI starting in 1984. Once a loss making institution channeling government subsidized
credits to inhabitants of rural Indonesia it is now the largest MFI in the world, being
profitable even during the Asian financial crisis of 1997 – 1998.43
In February 1997 more than 2,900 policymakers, microfinance practitioners and

representatives of various educational institutions and donor agencies from 137
different countries gathered in Washington D.C. for the first Micro Credit Summit. This
was the start of a nine year long campaign to reach 100 million of the world poorest
households with credit for self employment by 2005.44 According to the Microcredit
Summit Campaign Report 67,606,080 clients have been reached through 2527 MFIs by
the end of 2002, with 41,594,778 of them being amongst the poorest before they took
their first loan.45 Since the campaign started the average annual growth rate in reaching
clients has been almost 40 percent.46 If it has continued at that speed more than 100
million people will have access to microcredit by now and by the end of 2005 the goal
of the microcredit summit campaign would be reached. As the president of the World
Bank James Wolfensohn has pointed out, providing financial services to 100 million of
the poorest households means helping as many as 500 – 600 million poor people.47
41
See Bhatt (1997).
42
See Yunus (1998a), p. 143 et sqq.
43
44
See Daley-Harris (2003), p. 3.
45
“The Microcredit Summit Campaign defines “poorest” as those who are in the bottom half of those
living below their nation’s poverty line or are living on less than $1 a day, adjusted for purchasing power
parity (PPP)” See Daley-Harris (2003), p. 3. This definition will also be used throughout this paper.
46
47
12
3. The Impact of Microcredit
3.1. Microcredit and the Millennium Development Goals
In 1996 Ismail Serageldin, the then chair of the Consultative Group to Assist the Poorest
(CGAP)48 claimed that “[m]icrofinance is a proven instrument to assist the very poor.”49
This view is also shared by the World Watch Institute50 and underlines what has been
stated above, namely, that microfinance can be used as a strong anti-poverty tool. But
does microfinance actually meet these expectations and keep this promise?51
The impact that microcredit has on the lives of poor people will be demonstrated by
showing how it contributes to each of the eight Millennium Development Goals
(MDGs),52 which are related to the reduction of poverty in all its forms. These goals
were resolved in September 2000 by the General Assembly of the UN in their
Millennium Declaration.53
3.2. The Eradication of extreme Poverty and Hunger
The aim of the first MDG is to halve the proportion of people who live on less than $1 a
day between 1990 and 2015. According to current population projections of the World
Bank,54 this would equal 849 million people in 2015.55
48
The Consultative Group to Assist the Poorest is a consortium of 28 public and private development
agencies working together to expand access to financial services for the poor in developing countries and
was established by the World Bank in 1995. Recently it changed its name to Consultative Group to Assist
the Poor.
49
See Serageldin (1996), p. 11.
50
See Gardner (2002), p. 18.
51
See Morduch (1999a), pp. 1569 et sqq.
52
The Millennium Development Goals are: (1) eradicate extreme poverty and hunger; (2) achieve
universal primary education; (3) promote gender equality and empower women; (4) reduce child
mortality; (5) improve maternal health; (6) combat HIV/AIDS, malaria, and other diseases; (7) ensure
environmental sustainability; and (8) develop a global partnership for development.
53
See United Nations (2000).
54
See World Bank (2004), p. 38 et sqq.
55
Although it is not explicitly mentioned in the Millennium Declaration, it is commonly assumed that the
share of people living on less than $1 in low and middle income countries should be halved. If the share
would be calculated with regard to the world’s total population, the goal for 2015 would 818 million
people. For the world’s total population in 1990 see U.S. Census Bureau (2004).
13
Today almost 1.1 billion people live on less than $1 and more than 2.7 Billion live on
less than $2 per day.56 The mean income for those living under $1 a day is $0.77 and it
is $1.25 for those living under $2 a day.57 While the number of people living on less
than $1 per day is slowly decreasing and is expected to be 913 million in 2015, the
number of people living on less than $2 a day is actually increasing.58 One of the
outcomes from this degree of poverty is that more than 27,000 children die every day
from mostly preventable diseases, many of them related to hunger.59
Microcredit enables poor people to start new businesses, or to diversify existing ones,
which helps them to increase their income. In addition to large amounts of anecdotal
evidence, several studies have documented the positive economic impact microcredit
has on its clients. Cloud and Panjaitan-Drioadisuryo have found that the average income
of a sample of BRI borrowers has increased by 112 percent and that 90 percent of their
families have crossed the poverty line.60 Only 12 out of the 121 respondents of that
study reported that their income had not increased.61 According to the Grameen Bank
website, 51.09 percent of their clients have crossed the poverty line since they took their
first loan.62
A study conducted by Barnes showed that the program of the Zambuko Trust, a local
MFI in Zambia, had a considerable impact on the poorest clients consumption of meat,
fish and chicken.63 While 76 percent of the continuing clients of the MFI called Share in
India significantly increased their income and 50 percent have crossed the poverty line,
64
Khandker discovered in his well known study “Fighting poverty with microcredit”,
that there is a connection between the microcredit programs of three Bangladeshi MFIs
and household per capita expenditure. For every dollar borrowed by a Grameen Bank
member, household consumption increases by $0.18. In addition he found that 5 percent
56
See Chen and Ravallion (2004), p. 29.
57
In fact those people live on less than $1.08 and $2.15 respectively a day in 1993 PPP. This means that
the nominal dollar value of their income is considerably lower. See Chen and Ravallion (2004), p. 9.
58
Both numbers are decreasing in Asia but increasing in the rest of the world. See Chen and Ravallion
(2004), p. 22 et sqq.
59
See UNICEF (2002), p. 6.
60
A consistent definition of the term “poverty line” does not exists among different nations Therefore the
term will be used according to the definition of the respective country in this paper.
61
See Panjaitan-Drioadisuryo and Cloud (1999), p. 775.
62
See Grameen Bank (2004).
63
See Barnes (2001), p. 86.
64
See Simanowitz and Walter (2002), p. 16.
14
of Grameen Bank borrowers move out of poverty every year.65 Supposing Khandker’s
findings were correct for all MFIs worldwide and the Microcredit Summit Campaign
achieved its goal of reaching 100 million of the poorest households with microcredit by
2005, then 25 million people (assuming an average family size of five) would leave
poverty every year.66 Although this number would have to be adjusted in order take into
consideration the MFI clients who have crossed the poverty line already, and of course
the experiences made in Bangladesh can not be transferred precisely to other countries,
it still demonstrates the enormous effect that microcredit can have on assisting the
poorest to move out of poverty.
Although a 1996 study of Hulme and Mosley states that providing microcredit can also
have a negative impact on the income of the poorest households,67 these findings can
be considered as disproved by the recent bulk of evidence drawing favorable
conclusions.68
3.3. Achievement of universal primary Education
The aim of the second MDG is to ensure that all children will be able to complete
primary school by 2015.
Currently more than 100 million children, most of them girls, are not in school.69
Besides school fees, poor households often can not afford to send their children to
school because they need them to help in the family business.
Microcredit programs mainly contribute to the second MDG by increasing families

income and therefore enabling parents to send their children to school. Barnes, Gaile
and Kibombo found that clients of an MFI in Uganda spent significantly more on
children’s education than non-clients,70 and in Zambia Barnes showed that ongoing
participation in the Zambuko Trust’s program had a positive impact on the members
65
See Khandker (1998), p. 56.
66
67
See Hulme and Mosley (1996), p. 180 et sqq.
68
See Gibbons and Meehan (1998), p. 136.
69
See UNICEF (2002), p. 22.
70
See Barnes, Gaile and Kibombo (2001), p. 64.
15
children staying in school.71 In Bangladesh, the probability of girls enrolling in school
increased by 1.9 percent for every 1 percent increase in Grameen Bank loans to female
clients. For boys this number was even higher with the mean being 2.4 percent.72
3.4. Promote gender Equality and empower Women
The aim of the third MDG is to eliminate the disparity in the ratios of girls to boys in
primary, secondary and tertiary education, in the ratio of literate females to males and to
increase the share of women in the labor market and in parliament.73
At present the literacy rate for women is lower than for man all over the world.
According to the Human Development Report 2004, the average female literacy rate as
a percentage of male literacy rate is 75.9 in developing countries and is as low as 37 in
Niger.74 But women are not only discriminated against in education but also in access to
medical services and therefore have a higher mortality rate than man.75 The worldwide
tendency for women to be underrepresented in the labor market and in the parliaments is
even more severe in developing countries.76 Although several women have become
heads of state in various Asian countries (e.g. Bangladesh, India and Indonesia) this is
probably due to them being wives or daughters of former respected male politicians.
Since women have a higher repayment rate than man77 and also tend to invest increases
in income on the household and on their children rather than on themselves,78 most
MFIs prefer female clients.79 Therefore they empower women in many ways. Often
MFIs not only encourage women to become involved in financial transactions for the
first time, but also to become independent, active members of the economy and to
acquire assets in their own names. Cheston and Kuhn found that 68 percent of the
women participating in an MFI program in Nepal “… experienced an increase their
71
72
See Khandker (1998), p. 49.
73
See World Bank (2001), p. 20.
74
See UNDP (2004), pp. 225 et sqq.
75
See Sen (2000), p. 232.
76
See Sen (2000), pp. 242 et sqq.
77
See Littlefield, Morduch and Hashemi (2003), p. 7.
78
See Yunus (1998a), pp. 116 et sqq.
79
According to the Microcredit Summit Campaign Report 79%, or 37,677,080 of the poorest clients were
women. See Daley-Harris (2003), p. 3.
16
decision-making roles in the areas of family planning, children’s marriage, buying and
selling property, and sending their daughters to school - all areas of decision making
traditionally dominated by men.”80 The program of the Lower Pra Rural Bank in Ghana
had an positive impact on women’s participation in the community81 which is true as
well for the CRECER program in Bolivia.82 In Bangladesh the Grameen Bank and the
Bangladesh Rural Advancement Committee (BRAC), the two biggest MFIs of the
country had a significant positive effect on women’s empowerment measured through
eight different indicators.83 After joining Grameen Bank only 21 percent of the female
members considered themselves as unemployed, while this number was 50 percent
before joining.84 According to the Grameen Bank website, 93 percent of the Bank’s
shares are owned by their borrowers which elect the members of the board every three
years. They also get familiar with the election process by more frequently voting for
representatives at the lower level of the organizational structure. Partly because of this
experience, they are more likely to run for public office. In the 2003 local government
elections Grameen Bank members constituted 24% of the seats reserved for women,
while they represent less than 10% of Bangladeshi adult female population.85 Female
clients of MFIs from countries like the Philippines, Bolivia and Nepal have reported
similar occurrences.86
3.5. Reduce Child Mortality and improve Maternal Health
The aim of the fourth MDG is to reduce the under-five mortality rate by two-thirds
between 1990 and 2015 and the fifth MDG strives for a three quarter reduction in the
maternal mortality ratio by the same date.
As has been stated above, more than 10 million children are dying annually in the
developing world of mostly preventable causes with malnutrition playing a role in over
80
See Cheston and Kuhn (2002), p. 18.
81
See MkNelly and Dunford (1998), p. 54.
82
See MkNelly and Dunford (1999), p. 71.
83
The eight different indicators are: “freedom of movement, economic security, ability to make small and
larger independent purchases, participation in important family decisions, relative freedom from
domination by the family, political and legal awareness, and participation in political campaigning and
public protests.” Hashemi and Schuler (1998), p. 36.
84
See Holcombe (1995), p. 51.
85
See Grameen Bank (2004)and CIA (2004).
86
See Littlefield, Morduch and Hashemi (2003), p. 8.
17
half of the child’s deaths and in over 50 countries child mortality rates are greater than
100 deaths per 1,000 live births.87 Maternal mortality is also a significant problem in the
developing world with more than 500,000 women dying every year from pregnancy
related causes.88
MFIs are mainly contributing to the these MDGs by increasing families income and
therefore enabling the households to afford better nutrition and medical services.
Furthermore, they are often linked with microinsurance or health education programs.
In addition to what has been showed in chapter 3.1., Pitt, Khandker and Millimet
estimate that a 10 percent increase in the loan size of a female borrower in Bangladesh
increases the arm circumference of their daughters by 6.3%.89 Smith and Jain found that
village banking in Ecuador had a positive effect on child diarrhea90 which is responsible
for 15% of child deaths.91 Since Sen argues that an improved status of women within
the family reduces child mortality,92 the empowerment of women through MFIs is also
contributing to this cause.
Although no study has been conducted so far on the direct impact of microcredit on
maternal health, it can be assumed that an overall improvement of access to medical
services reduces maternal mortality as well. A study of the Morgan State University, for
example, suggests that microcredit has a positive effect on the prevalence of
contraceptives93 which leads to a decrease of unwanted pregnancies and therefore
reduces maternal death.
3.6. Combat HIV/AIDS, Malaria and other diseases
The aim of the sixth MDG is to halt and begin to reverse by 2015 the spread of
HIV/AIDS, malaria and other major diseases and to assist children orphaned by HIV.
87
88
See WHO (2004) .
89
See Pitt, Khandker and Millimet (2003), p. 113.
90
See Smith and Jain (1999), p. 37.
91
See WHO (2001).
92
See Sen (2000), p. 235.
93
See Amin et al. (2001), p. 1614.
18
In 2003 2.9 million people died because of HIV and about 4.8 million became infected,
the greatest number since AIDS was discovered 23 years ago.94 This pandemic has lead
to a tremendous decrease in the life expectancy in the hardest hit countries. Botswana
for example, one of the richest and most democratic countries in Africa, has a
HIV/AIDS adult prevalence rate of 38.8% and a life expectancy at birth of less than 31
years.95
Malaria not only causes more than one million deaths annually, it leads also to 300 –
500 million clinical cases a year. Both numbers have been steadily increasing over the
past two decades.96 More than two million people a year are killed by tuberculosis,
another global health problem. This curable disease is estimated to cost poor
communities about $12 billion every year, since even those who survive normally lose
more than 3 month of work time while recovering.97
MFIs contribute to the sixth MDG in several ways. By increasing client’s income, they
help households affected by HIV or other diseases to better cope with the situation.
Besides spending more money on health services and nutrition, MFI clients also tend to
be more able and willing to support AIDS orphans than non clients.98 In addition to the
already stated increase in the use of contraceptives,99 several innovative approaches to
deal with disease related crisis have also arisen. This is, of course, necessary not only to
counteract the devastating effect the above discussed epidemics can have on MFI
clients, but also to not put the viability of the respective institution at risk. One option is
to integrate education services in the MFI programs and encourage clients to form
solidarity groups.100 It has been shown that these services do not necessarily decrease
the effectiveness of the institutions’ employees.101 Another way is to strengthen the ties
to NGOs specialize in dealing with the respective disease. Synergies gained through this
cooperation can help clients to better deal with the situation and in the end increase their
94
See UNAIDS (2004), p. 23.
95
See CIA (2004).
96
97
98
99
See also Kim et al. (2002), p. 18.
100
See Donahue and Sussman (1999), p. A 14.
101
See Donahue, Kabbucho and Osinde (2001), p. 25.
19
repayment rates. Various MFIs also have introduced loan and health insurance products
or cultivated linkages with organizations doing so.102
It has to be stated that despite the benefits MFIs can provide to people effected by
HIV/AIDS or other diseases, microcredit can also be a burden for those who are already
chronically ill. These people can still benefit through loans provided to members of the
family or the community, or through one of the other services mentioned above.
3.7. Ensure environmental Sustainability
The aims of the seventh MDG are to support and promote the principles of sustainable
development and put them into action and to improve the lives of slum dwellers and
people without sustainable access to safe drinking water and sanitation.
Today climate change is considered as the major environmental problem.103 The

Intergovernmental Panel on Climate Change (IPCC) states that human activities
contribute to most of the 0.6 °C increase in global average temperature over the 20th
century and the predicted increase of another 1.4 to 5.8 °C between 1990 and 2100.104
Emission of carbon from fossil fuel is reported to have the dominant influence on this
development. While the total emission was 1.6 billion tons in 1950, it was already 6.5
billion tons in 2000 and is expected to continue to grow.105 This development would
lead to a rise in the average sea level of between 9 and 88 centimeters during the next
century.106 Furthermore it is predicted that global warming increases the risk of extreme
events like cyclones or floods, leads to an increase in the number of people infected by
diseases like malaria and decreases the potential crop harvest and water availability,
especially in developing countries.107 In 2000 already 1.1 billion people lacked access to
clean drinking water and 2.4 billion to basic sanitation.108
102
See Barnes (2001), p. 40; Barnes, Gaile and Kibombo (2001), p. 13 and Grameen Bank (2004).
103
See Gardner (2002), p. 5.
104
See IPCC (2001), pp. 2 et sqq.
105
Worldwatch Institute (2002), p. 52 et sqq.
106
See IPCC (2001), p. 16.
107
See Dunn and Flavin, p. 29.
108
See UNFPA (2004), p. 18.
20
MFIs contribute to achieving the seventh MDG in several ways. By providing loans for
the purchase of renewable energy technologies, they help people in developing
countries to increase their per capita energy consumption without increasing the carbon
dioxide emission. In a 2003 survey of 140 MFIs from 80 different countries, 21 said
they provide credits for solar home systems and another 19 stated they are interested in
becoming engaged in this business.109 While Grameen Shakti, a rural energy service
company cooperating with the Grameen Bank in Bangladesh, has already installed more
than 23,000 solar home systems,110 a 2000 World Bank study reports twelve projects
providing solar home systems to rural households with a target of 500,000
installations.111 It has also been suggested that MFIs should raise environmental
awareness among their clients,112 but so far no data is available on how staff can cope
with this additional task. Many MFIs also provide loans for improvements in sanitation
and the water supply of their clients. Varley gives several examples from Africa, Asia
and Latin America on how microcredit not only has helped to invest in rainwater
collection systems, but also how it has enabled households to increase their water
supply through community water associations.113 In addition many MFIs provide credit
for the construction of sanitary latrines.114 The situation of slum dwellers is also
positively effected by MFIs. Directly through their services in poor urban communities
and indirectly by creating jobs in rural areas and therefore easing the pressure on urban
labor markets.
3.8. Develop a global Partnership for Development
The eight MDG is about the means to achieve the other seven MDGs. It calls for all
players involved in the endeavor of development and poverty eradication to work as
partners in a global context.
Again MFIs are contributing to the eight MDG in many ways. This is occurring through
international networks that provide funding and technical assistance, through internet
information portals and specialized journals, through social and for profit investors and
109
See Wimmer and Barua (2004), p. 174.
110
Barua (2004).
111
See Martinot and Cabraal (2000), p. 6.
112
See Pallen (1997), p. 11; Lal (n.d).
113
See Varley (1995), pp. 39 et sqq.
114
See Jalvaani (1999), pp. 1 et sqq.; Varley (1995), pp. 39 et sqq.
21
specialized rating agencies. The Bangladesh-based Grameen Trust is one of around 30
networks in operation. Besides collaborating with over 200 MFIs around the world, it
has directly operated three projects in Afghanistan, Kosovo and Myanmar.115 While the
ACCION network serves almost 1.2 million active clients in 19 countries throughout
America and sub-Saharan Africa,116 FINCA’s network operates in three different
continents where it serves more than 200,000 customers.117 In November 1997 the
MicroBanking Bulletin (MBB) was first published by the microfinance program at the
Economic Institute at the University of Colorado.118 Its aim is to develop a database on
the financial performance of MFIs from all over the world which is now available
through the Mix Market, an internet portal that also provides information about more
than 300 MFIs, investors, donor institutions and other related development
organizations.119 Two years later the Marriott School at Brigham Young University
started to publish the Journal of Microfinance which has an editorial board of
microfinance experts from all over the world and offers the latest research on this
topic.120 In the late 1990s a number of companies became attracted by the microfinance
market and started to invest in MFIs. The German based Internationale Mikro
Investitionen Aktiengesellschaft (IMI), for example has already invested more than €46
million in 19 MFIs in four different continents and plans to invest another €27 million
before October 2004.121 BlueOrchard Finance, a microfinance investment consultancy,
has channeled more than $60 million worth of private capital to some 40 MFIs
worldwide through investment funds and bond issues.122 Big commercial banks like
Citigroup, Deutsche Bank and ABN Amro also started to get involved in the
microfinance sector, although this is mainly still perceived as a public relation activity
and not as a for-profit investment.123 There are also several rating agencies specializing
in MFIs. Dependent on their rating, these institutions can help MFIs to receive money
from donors or investors. Four of the most prominent rating agencies are PlanetFinance
115
See Grameen Trust (n.d.).
116
See ACCION (n.d.).
117
See FINCA (n.d.).
118
119
See The Mix (2004).
120
See Woodworth and Woller, (1999), p. 6.
121
See IMI (2004).
122
See BlueOrchard (2004b), p. 3.
123
See Busch and Kort (2004), p. 8; Fischer (2003), p. 6.
22
with headquarters in France, M-Cril based in India, Microfinanza in Italy and
MicroRate with offices in the USA and South Africa.124
124
See Microfinance Rating and Assessment Fund (2004).
23
4. Microcredit Outreach
4.1. The Demand for Microcredit
Although it has been shown that microcredit is one of the most effective poverty
eradication tools, that it is considered a human right by some of its advocates125 and it
can contribute considerably to the development of the financial sector in developing
countries, an enormous gap still exists between supply and demand for microcredit.
Estimates on the demand for microcredit vary greatly. While USAID estimates the
number of potential microfinance clients is between 100 and 200 million,126 the
Microcredit Summit Campaign states the total demand is more than 234 million
people.127 CGAP recognizes some 500 million micro-entrepreneurs who have the
potential to become customers of MFIs.128
Marguerite Robinson calculates the demand as follows: “Assuming five people to a

household among the 4.5 billion people living in low- and lower-middle-income
economies in 1999 (World Bank, World Development Report 2000/2001), there are 900
million households in those economies. If, estimating conservatively, we assume that
informal commercial moneylenders supply credit to 30 percent of these households at
least once a year, this would mean that there are 270 million households borrowing
from informal moneylenders in a year. Undoubtedly, however, many of these
households borrow multiple times within a year.”129 Although this is a very rough
estimate, assuming big differences in demand for microcredit in different countries, the
number seems to be the most meaningful. In contrast to the estimate of the Microcredit
Summit Campaign it does not include every single household living on less than $1 a
day, but, according to the definition presented in chapter 1., it counts everyone who has
no regular access to traditional financial institutions, but demands such services.
Obviously not all people who draw on moneylenders have financial needs that could be
matched through MFIs. On the other hand, interest rates charged by moneylenders tend
125
See Yunus (1998b).
126
See Christen et al. (1995), p. 15.
127
See Daley Harris (2003), p. 22.
128
129
24
to be considerably higher than those of MFIs. The former normally charge effective
monthly rates between ten and several hundred percent per month, the latter generally
charge between 1.5 and five percent which enables them to attract additional clients.130
4.2. The Supply of Microcredit
In spite of the impressive growth of MFIs around the world, the demand for microcredit
is far from being met and this it is not likely to change in the near future. The
Microcredit Summit Campaign reported that by the end of 2002, 67,606,080 clients131
were reached through MFIs and that this number has increased by almost 40 percent
annually for the last five years.132 It is likely that this tremendous speed of growth is at
least partly due to including MFIs which have not been reporting to the Campaign from
its start in 1997 although they have already existed at that time. These institutions
contributed 22 percent to the growth in poorest clients in 2000, 57.8 percent in 2001 and
33.8 percent in 2002. The growth of the poorest clients increased at least party because
of an expanded definition of the term “poorest”.133 Since the contribution of MFIs
which previously have not been considered can be expected to decrease dramatically,
the growth rate as stated by the Microcredit Summit Campaign can not be used to
predict the future development of the microfinance sector. Another factor likely to slow
down the growth is the concentration of microfinance activities in some Asian countries
where almost 90 percent of the poorest microfinance clients live today.134 Even if one
takes into consideration the relative size of Asia’s population and the fact that many
MFI customers in Latin America are relatively better off and therefore are not included
in this numbers, the coverage of this part of the world far exceeds the others. In
Bangladesh for example, the microfinance market is close to saturation. More than
eleven million households were served by several hundred MFIs in 2001.135 Among
them are Grameen Bank and BRAC, two of the best known MFIs in the world, both
providing their services to more than three million customers. With an average
household size of five it can be assumed that in Bangladesh the number of people
130
See Gibbons and Meehan (1999), pp. 144 et sqq.
131
41,594,778 of them belonged to the poorest before they took their first loan. The relative numbers in
the following are for these poorest clients only since no other current data was available. It can be
assumed though, that this works as a good proxy for the total number of clients.
132
133
134
135
See Ahmed (2003).
25
benefiting from microcredit already surpasses the number of people living below the
poverty line, which is estimated to be slightly higher than 50 million.136 Therefore
Bangladesh will not contribute to the growth of the microfinance sector as much as it
has done in previous years. This is also true for Vietnam, Thailand and to a lesser
extent Indonesia. Eight of the nine MFIs serving more than one million clients are based
in these countries while the ninth is based in India where, due to its one billion
inhabitants, the microfinance market is still far from saturation.137 In contrast, the
supply in Brazil meets less than two percent of the demand, which is estimated to be
about 5.8 million potential clients.138 For these reasons, greater amount of future growth
must come from smaller or new MFIs in Latin America, India, China and especially
Africa, where almost 30 percent of the world’s poorest live.139
4.3. Meeting the Demand
To fill the gap between the demand and supply for microcredit, tremendous investments
are necessary to increase the loan funds of MFIs and build up their capacity through
upgrading existing institutions, or building new ones. Again, estimates on how much
capital is needed vary greatly with the highest being at more than $300 billion.140
In 1997 the Microcredit Summit Campaign estimated that $21.6 billion would be
needed to achieve their goal of providing microcredit to 100 million of the poorest
households. This was calculated in the following way: Since some 8 million people
already received microcredit in 1997 another 92 million needed to be reached.
Assuming $200 ($150 for loan fund and $50 for capacity building) would be needed per
person for 88 million people in developing countries and $1000 ($500 for loan fund and
$500 for capacity building) would be needed for 4 million people in industrialized
countries, the capital required ends up to be $21.6 billion.141 For several reasons, this
136
See CIA (2004).
137
These institutions are: The Grameen Bank, BRAC, Proshika and the Association for Social
Advancement (ASA) in Bangladesh; the Vietnam Bank for Agriculture and Rural Development
(VBARD) and the Vietnam Bank for the Poor (VBA) in Vietnam; BRI in Indonesia; Bank for Agriculture
and Agricultural Co-operatives (BAAC) in Thailand; the National Bank for Agriculture and Rural
Development (NABARD) in India. See Ahmed (n.d.), p. 1; Llanto (n.d.), p. 337.
138
See Mezzera (2002), p. 23.
139
See See Chen and Ravallion (2004), p. 29.
140
See Clear Profit (2004); Prisma (2002).
141
See The Microcredit Summit (1997).
26
number is not qualified to predict the total amount of capital needed to meet the demand
for microcredit. On the one hand, it focuses mainly on the low end of the market and
therefore underestimates the average loan fund needed. On the other hand it does not
take the increasing capital demand from established MFIs into account. A survey of 119
MFIs found that the average loan size to increased from $406 in 2002 to $498 in
2003.142 This is mainly due to the fact that MFI clients once they have paid back their
loans, usually demand larger ones for the continual development of their businesses,
and therefore further increase the demand for capital of established MFIs. The Grameen
Bank for example has a ceiling on its loans which increases or decreases depending on
the borrowers performance regarding repayments and savings.143 While the maximum
amount for the first loan is fixed at approximately $75,144 the largest loan disbursed so
far was $17,195.145 Thus, if one estimates that by now 100 million people are borrowing
from MFIs,146 another 170 million need to be reached to meet the estimated demand.
Assuming an average of $600 ($400 for loan fund and $200 for capacity building) is
needed for every new client and another $200 is needed for every existing client to meet
the demand for larger loans, a total of $122 billion is required. This rough estimate
helps to convey the approximate amount of capital needed to meet the demand for
microcredit.
So far the demand for funds is being partly met by donors which annually provide
between $500 million and $1 billion,147 and through the mobilization of local savings.
Obviously the amount of money provided by donors will not be able to meet the capital
demand for microcredit in the short term. The mobilization of savings on the other hand
has been extremely successful in some cases, with BRI probably being the most
prominent example. After adapting commercial principals in October 1984 BRI was
able to raise its deposits from $161,060 to more than $3.2 billion in 2003, which equals
almost two times its current loan portfolio.148 Many other MFIs like BDB in Indonesia,
142
Own calculations. Without BRI the numbers would be $343 and $409. See Appendix 1.
143
See Grameen Bank (2003), p. 13.
144
The accurate amount is 5000 Taka. See Interview with Shaw Newaz.
145
Grameen Bank (2004).
146
According to the data provided by the Daley Harris (2003), an annual increase in MFI clients of
approximately 25 percent from 31.12.2002 till the 30.9.2004 would be needed to reach 100 million clients
by now. This rated is considerably below the average of the previous five years (38 percent). Therefore it
can be assumed as realistic, despite the growth hindering factors presented above.
147
See CGAP (2003), p. 8.
148
See Robinson (2002), p. 273; Mix Market (2004).
27
XacBank in Mongolia, the Equity Building Society in Kenya or the Centenary Rural
Development Bank in Uganda also have managed to cover their loan portfolio fully
through internally mobilized resources.149 The Grameen Bank is also expected to do so
in the first half of 2005.150 In addition to raising much needed capital for on-lending, the
provision of saving services can deliver notable social benefits itself.151
Despite these impressive achievements, even the combination of donor money and local
savings at their current levels, will not be able to provide the capital needed to continue
the rapid growth of the microfinance sector. Especially in their early years, MFIs rely on
outside funding. BRI for example needed six years before the amount of locally
mobilized savings surpassed the total amount of outstanding loans. During this time
expenses and the loan portfolio were covered through a government grant worth $20
million and two World Bank loans of $5 and $97 million respectively.152 It also
benefited from a network of more than 3,600 branches which were established
throughout the country during the 1970s and early 80s in order to provide government
subsidized credit in rural areas.153
The Grameen Bank, also widely known as a best practice MFI, has received about $175
million in direct and indirect subsidies between 1985 and 1996154 and continues to rely
on outside funding at below market interest rates. This is made possible either through
special loans from the Bangladesh Bank, or through offering bonds guaranteed by the
Bangladesh government155 - an option most MFIs do not have. BDB might be one of the
very few examples which were able to finance their activities through savings and
commercial loans from the start, but its outreach did not reach a large scale, nor did it
serve the low end of the market. In 2000, after 30 years of operation, BDB provides
credit to only 10,417 clients with an average loan balance of more than $5,000,156
approximately eight times the countries GDP per capita.157
149
See Mix Market (2004).
150
See Grameen Bank (2004)
151
See Robinson (2001), pp. 263 et sqq.
152
See Seibel and Schmidt (2000), p. 4.
153
154
See Morduch (1999b), p. 8.
155
See Morduch (1999ba), p. 25 et sqq.
156
157
See CIA (2004).
28
Another problem keeping many MFIs from collecting savings is that they do not want
to become a regulated financial institution or do not meet the criteria in their respective
country and therefore they are simply not allowed to mobilize savings from the public.
In summary, the examples and numbers presented in this chapter support the argument
that the amount of capital that can be raised through donors and locally mobilized
savings is not enough for continuous rapid growth of the microfinance sector. If this
lack of capital is not met through other sources, the microfinance sector will fail to
contribute its full potential to the achievement of the MDGs.
4.4. Microfinance and the Capital Markets
Regardless of whether the amount of capital needed for the development of the
microfinance sector is $20 or $300 billion, it represents only a tiny fraction of the
worldwide capital markets which are estimated at $30 trillion.158 Therefore, if the
microfinance industry were able to tap the financial markets it would be able to grow
much faster and soon serve the millions of micro-entrepreneurs which currently can not
develop theirs businesses because of capital constrains. Another advantage would be
that scarce donor money currently, used for the development of the microfinance sector,
could be used for other projects that do not have the potential to draw money from
commercial sources. This view is shared by Michael Chu, the former CEO of ACCION
who made the following statement in 1998: “Microfinance today stands at the threshold
of its next major stage, the connection with the capital markets.”159 Many attempts have
been made since that time. Successful MFIs like BancoSol in Bolivia further
strengthened their ties to the capital markets which, in some cases, already provide the
majority of their funding.160 Microfinance investment advisors like BlueOrchard
Finance have become middlemen for MFIs and the financial markets. Nevertheless
these links are still far from reaching major scale. Currently only approximately 20
percent of MFIs funding comes from commercial sources,161 and the biggest bond issue
dedicated to fund MFIs totals only $40 million. In addition these funds mainly end up
158
See Brynjolfsson (2004).
159
Chu (1998), quoted in Robinson (2001), p. 23.
160
161
See Dominicé (2004).
29
in established institutions in Latin America or Eastern Europe,162 while smaller
organizations only benefit indirectly, if at all.
162
See Clear Profit (2004); IMI (2004).
30
5. Credit Rationing
Until recently the predominant answer to why commercial banks or venture capital
companies did not invest in the microfinance sector was that the poor are not bankable.
Besides lacking education and therefore not being able to deal with formal financial
institutions, they were viewed as bad credit risk who were unable to invest the borrowed
money in a way that would allow them to repay the loan and interest at a commercial
rate.163 Another reason that kept attention away from the idea of providing financial
services to low income people was the belief that informal moneylenders already met
this demand. These skeptics felt affirmed through the poor performance of subsidized
credit programs as described in chapter 2.2.. Although it is true, that moneylenders
serve a huge number of people in the developing world, they more often than not charge
usury interest rates of up to 20,000 percent per month.164 While the argument that poor
people are not able to participate in the formal financial market can be overcome by
adapting the services accordingly,165 the claim of low returns on their investments is not
only proved wrong by empirical evidence, but also contradicts economic theory as will
be shown in chapter 5.3.
5.1. The imperfect Information Paradigm
A more elaborate explanation for the short supply of financial services to low income
people that can be derived from the imperfect information paradigm based
predominantly on the works of Akerlof166 and Stiglitz and Weiss.167 After giving a brief
summary of their argument an adaptation of their findings to the microfinance market
will be presented and subsequently it will be shown how their conclusions can be
overcome.
Behind the imperfect information paradigm lies the theory of asymmetric information
which simply states that if two parties conduct a transaction, one is likely to have more
163
See Ghatak (1983), p. 21 et sqq., Yunus (1998), p. 102 et sqq.; Robinson (2001), p. 35 et sqq.
164
165
See Seibel (2003b), p. 2; BRAC (2003), pp. 15et sqq.; Yunus (1998), pp. 151 et sqq.
166
See Akerlof (1970), pp. 488 et sqq.
167
See Stiglitz and Weiss (1981) pp. 393 et sqq.
31
information than the other and is trying to use that for its own advantage.168 Applied to
the banking sector this means that a person applying for credit can better judge the
likelihood of repaying the loan than the bank. This is because the borrower has better
knowledge of the market she wants to invest in, her skills and her willingness to repay.
Moreover the bank might not be able to observe if the borrower uses the loan for the
agreed purpose. These occurrences can lead to what is known as adverse selection and
moral hazard. In this case adverse selection refers to the problem that banks might
attract borrowers with a low probability of repayment if they can not distinguish
between high and low risk loan applicants. Moral hazard occurs after the provision of
the loan when the borrower spends the money on a purpose different to the prescribed
purpose and therefore lowers the probability of repayment. This can happen e.g. by
investing in a more risky project or through spending the money on consumption. If the
bank is not able to find a cost effective way to avoid these problems, it might raise its
interest rate in order to compensate for the increased risk.
Figure 1: Expected Bank Return and the Interest Rate

Source: Stiglitz and Weiss (1981), p. 394
EXPECTED RETURN TO THE BANK
I* INTEREST RATE
Since this might discourage low risk borrowers from applying for credit and encourage
borrowers who continue to take loans to invest in riskier projects, the share of high risk
168
See Neus (1998), p. 85 et sqq.
32
borrowers could increase and therefore reinforce the problems stated above. Thus
increasing the interest rate beyond a certain point actually leads to a decrease in the
expected return to the lender. This context is illustrated in figure 1 with I* being the
interest rate which maximizes the expected returns to the bank. Obviously the bank
would charge the interest rate I* in order to maximize its expected return. However, this
price for capital was not determined through supply and demand as economic theory
would predict. It is conceivable, that at the interest rate I* the demand for credit exceeds
the supply, but even if loan applicants would offer to pay a higher interest rate, the bank
would refuse because it associates such a loan with high risk. As a result credit might
be rationed.169
5.2. Adaptation to the Microfinance Sector
Through some adaptations this model can also help to explain the lack of funds
provided to low income people. In the original model of Stiglitz and Weiss several
assumptions have been made that need to be suspended in order to compare the credit
markets for low and high income people and give an explanation why the latter is
widely neglected by institutional investors.
Evidently the assumptions that the amount borrowed is equal for each loan applicant
and that transaction costs170 need not to be taken into account171 are not suitable for this
context. While the average loan size of MFI customers is much smaller than that of
clients from traditional banks, the transaction costs, as a share of the loan, are
considerably higher, because the lender’s costs for conscientious processing a credit
applications are only slightly smaller for a $50 loan than for a $100,000 or a
$10,000,000 loan.
In figure 2, the R(I)large curve represents the return to the bank for large loans with
regard to the interest rate I and the R(I)small curve describes the same correlation for
small loans. It is shifts downwards to reflect the assertion that the imperfect information
169
See Stiglitz and Weiss (1981), p. 394.
170
In this paper the term „transaction costs“ refers to the operating expense ratio as defined by MicroRate.
It “is calculated by dividing all expenses related to the operation of the institution (including all the
administrative and salary expenses, depreciation and board fees) by the period average gross portfolio.”
See MicroRate and Inter-American Development Bank (IADB) (2003), p. 16.
171
33
paradigm has a more severe effect on poor people, than on the better off. They are
expected to have less profitable investment opportunities at their disposal,172 and
therefore are more likely to invest in riskier projects which increase the probability of
default and hence decrease the expected return to the bank. Additionally, one might
expect poor people to be more likely than others to spend borrowed money on
consumption instead of an income generating activity, particularly if a crisis arises. It
seems understandable, that food or urgently needed medicine are given priority over
repaying a loan.
The second shift downwards is due to transaction costs. As stated above they are
relatively higher for smaller loans. Obviously transaction costs are incurred in the
provision of a large loan as well, but since they are much smaller with regard to the loan
amount they are not included in the diagram for reasons of clarity.
Figure 2: The extended Model

Source: Own diagram, adapted from Stiglitz and Weiss (1981), p. 394
Large
Loans
Small
Loans
R(I)large
Lack of
investment
opportunities
Transaction costs
R(I)small
I* INTEREST RATE
172
See Khandker (1998), p. 8
34
5.3. Overcoming Credit Rationing for the Microfinance Sector
If the conclusions in chapter 5.1. hold, it is rational for a profit maximizing investor to
neglect the microfinance sector as long as no surplus funds in the market for large loans
exist. This finding can help to explain the small amount of money provided to the
microfinance sector from commercial investors. On the other hand it has to be stated
that this theory is reflexive as defined by Soros173. It not only explains, but also forms
reality, since it has the potential to reinforce the view of potential investors, that
microfinance is a less profitable business.174 Therefore demonstrating under which
conditions microfinance can be profitable and, in some cases be more profitable than
traditional businesses is of crucial importance.
To provide a fairer view of the microfinance sector, a further assumption of the Stiglitz
and Weiss model that needs to be suspended is that all investments made by the
borrowers have the same expected return.175 As stated above this contradicts economic
theory which claims ceteris paribus capital productivity decreases while the amount of
fixed capital increases. In combination with a low capital endowment, micro-enterprises
are usually faced with an excess supply of unskilled labor, especially in developing
countries.176 Hence small enterprises use far less capital per employee than big business
and therefore their marginal productivity of capital is much higher.177 This is intuitive if
one imagines an economic actor who wants to invest several packages of capital.
Obviously she would invest the first package where she expects the highest return, the
second package where she expects the second highest return and so on. Each additional
investment opportunity would lead to lower, or at best, equal returns.178 While this
simplified example has limitations, it demonstrates how the marginal productivity of
capital can diminish. Although it might actually increase until a certain point,179 this can
be expected to be so low in this context, that it has no influence on the correlation as
shown in figure 2.
173
See Soros (1998), pp. 14 et sqq.
174
See Goodwin-Groen (1999), p. 8.
175
176
See Perkins et al. (2001), pp. 95 et sqq.
177
See Tschach (2000), p. 8.
178
See Rosenberg (2002), p. 11.
179
See Rechard G. Lipsey (1979), pp. 211 et sqq.
35
Figure 3: Marginal Productivity of Capital
Source: Dornbusch and Fischer (1995), p. 406
MARGINAL PRODUCTIVITY
0 FIXED CAPITAL
Even if good investment opportunities for poor people exist, the question remains if it is
possible to distinguish between high and low risk borrowers. The problem of adverse
selection is overcome in a cost effective way in many MFIs.180 For the better off poor
for example, institutions like BRI base their decision on whether or not to approve a
loan by assessing the repayment ability of potential borrowers from their current income
flows and not from the uncertain returns generated by the loan.181 Additionally
collateral is used in some cases to attract low risk borrowers.182 In contrast to
industrialized countries this is usually not done to cover the potential losses of the
lender, but to punish the defaulter and therefore increase her willingness to repay.183
Obviously this does not always work for the poorest, since they often neither posses any
goods that could work as collateral nor do they have sufficient earnings prior to
obtaining a loan for starting an income generating activity. Here the so called group-
lending model can help to identify creditworthy borrowers. The most prominent
institution using this approach is the Grameen Bank, which only provides credit to
180
See Farrington (2000), p. 20.
181
See Robinson (2001), p. 80; Robinson (2002), p. 238.
182
See Bester (1985), p. 850 et sqq.
183
See Schmidt and Tschach (2001), p. 15; Robinson (2002), p. 244.
36
members of a group of five. These groups are formed by their members without
interference of the Grameen Bank. Although in this particular case no joint liability
exists for the members of the group, nobody can receive a new loan if another member
of the group fails to repay on time.184 Therefore the group formation work as a
screening process. Since the borrowers do not want to risk their ability to obtain further
loans, they carefully select with whom to form a group. Usually the members know
each other for a long period of time and therefore they can make a meaningful judgment
of each others’ ability to repay the loan. Other MFIs even require the members of a
group to mutually guarantee each others’ loans.185 While this might further increase
borrowers’ efforts to search for trustworthy group members, it might also keep potential
borrowers from applying for a loan since she does not want be held responsible for
defaulting members. This mechanism enables MFIs to partly pass on the transaction
costs related to the selection of low risk borrowers, to the borrowers themselves.186
Many MFIs have also largely overcome the problem of moral hazard by creating
incentives to ensure a high repayment rate, even among the poorest. In some cases their
customers go hungry in order to pay back their loan even though no legal action would
be taken against them if they would refuse to do so.187 One way to achieve this is to
build up peer pressure through the formation of groups as described above.188 Another,
and probably the most important, is to limit access to future loans to those borrowers
who repay on time. The demand for successive loans is extremely high. In a 1996
survey, 98 percent of BRI borrowers planed to apply for another loan189 and in 1993
less than 30 percent of Grameen Bank loans went to first time borrowers.190 Especially
the poorest highly value the option to reborrow191 and many MFIs see this as their
primary incentive to ensure repayment.192 According to Schmidt and Tschach, “the net
present value of future access to credit works out to be roughly half the value of the
economic advantage to be gained from the intended non-repayment.”193 This can also
184
See Yunus (1998), p. 135.
185
See Schmidt and Zeitinger (1997), p. 6.
186
See Stiglitz (1990), p.353.
187
Own observation at the Grameen Bank in Bangladesh (2003).
188
See Hoff and Stiglitz (1990), p. 249.
189
190
See Khandker, Khalily and Khan (1995), p. 93.
191
See Gibbons (2000), p. 15; Hashemi and Schuler (1997), p. 43.
192
193
See Schmidt and Tschach (2001), p. 16.
37
explain the occurrence of a drop in the repayment rate once a MFI is no longer seen as
viable and therefore is not expected to provide loans in the future.194
With the help of the described mechanisms, MFIs around the world are able to keep
repayment rates high. A survey of 69 MFIs from 36 different countries, each serving
more than 10,000 clients in 2002, found the portfolio at risk (PAR)195 varied between
zero and 23.1 percent. While the average was 3.6 percent, the median was found to be
2.29 percent.196 One of the MFIs included in this sample is BRIs who’s 12-month loss
ratio has never exceeded five percent since the start of its transformation in 1984, and
from 1997 to 1998, the ratio actually fell from 2.2 to 1.94 percent.197 The latter deserves
special attention, because the Asian financial crisis reached its peak at that time with
Indonesia being hardest hit , as illustrated by a statement from The Economist in July
1998: "Even with the fierce competition from its neighbors, Indonesia would probably
walk away with the prize for Asia's most desperate banking system.”198
The findings that MFIs can adapt their services to low income people in order to ensure
a high repayment rate, and that poor people do not lack profitable investment
opportunities are illustrated in figure 4. From this diagram it can be seen, that under the
new assumptions the interest rate at which the bank maximizes its return differs for
large (I(l)*) and small loans (I(s)*). According to the assumption that micro-
entrepreneurs can realize a higher return on their investments, the bank can charge them
a higher rate of interest without bearing an increased risk. Nevertheless, in this example,
the bank would still serve the market for large loans first because of the higher
transaction costs for smaller loans.
The view, as described in figure 4, is shared among most traditional banks and investors
in industrialized as well as in developing countries. In addition to neglecting the
possibility of generating profits by offering microcredit themselves,199 they also hesitate
to lend to MFIs because they consider their business too risky.
194
See Schreiner (1997), p. 64.
195
“PAR shows the real risk of the portfolio by comparing outstanding loan balances for loans with at
least one late payment to the outstanding loan portfolio.” Gross and de Silva (2002), p. 22.
196
Own calculations. See Appendix 2.
197
See Seibel (2000), p. 11.
198
The Economist (1998), pp. 92 et sqq.
199
Busch and Kort (2004), p. 8 .
38
Figure 4: The extended Model
Source: Own diagram, adapted from Stiglitz and Weiss (1981), p. 394; Tschach (2000),
p. 17.
Large
Loans
Small
Loans
R(i)large Transaction costs
R(i)small
INTEREST RATE I(l)* I(s)*
This attitude can be observed by comparing the ratio of equity to liabilities, which is
considerably higher for MFIs than for conventional banks.200 When it comes to MFI
start-ups and those MFIs serving the low end market in remote areas even experienced
microfinance practitioners are skeptical if interest rates that fully recover all costs can
be charged.201
Theoretically there are two ways to adjust this model to arrive at a conclusion which is
more favorable with regard to the profitability of microcredit. One is to cut the
transaction costs and therefore reduce the downward shift of the R(I)small curve, the
other is to allow the bank to further raise the interest rate without experiencing a
decrease in its return. This means to increase I(s)* and the respective rate of return.
While in 2000 Tschach stated that transaction costs vary between 10 and 20 percent for
loans provided through the group lending model and between 15 and 30 percent for
200
See MicroRate and IADB (2003), p. 30.
201
See Volkery (2004), p. 33; Gibbons (2000), p. 15.; Gibbons and Meehan (2002), p. 29; Goodwin-
Groen (1999), p. 8.
39
individual loans,202 it was recommended in 1999 that MFIs should target a range
between 15 and 25 percent.203 Some best practices on the other hand have already
achieved single digit numbers. Currently BDB might be the most efficient MFI in the
world with transaction costs at just 4.7 percent in 2001.204 Even though the low costs of
BDB have to be acknowledged, its achievement has to be put in perspective. As stated
above, with an average loan balance of more than $5,000 it does not serve the low end
market. In addition it works in an environment with a high population density which
means that it can reach a relatively large group of borrowers per branch. This is a
comparative advantage many Asian MFIs enjoy as can be illustrated by comparing
Bangladesh and Bolivia. Both countries are at the forefront of the development of
microfinance in their respective continent, but while in Bangladesh more than 1,000
people are living per square kilometer, the average for Bolivia is only eight.205
Therefore it is consistent that the most efficient MFI in Latin America, Fondo
Financiero Privado para el Fomento a Iniciativas Economicas, has transaction costs of
11.4 percent.206 With an average loan size greater than the annual GDP per Capita, this
institution also does not serve the low end market.207
Despite the impressive efficiency gains in the described examples, most MFIs are far
from achieving these numbers and many are unlikely to reach them due to the
environment within which they work. A survey of 67 MFIs from 31 countries found the
average transactions costs in 2002 to be 27.9 percent with a median of 20.6 percent.208
However, even if these institutions were to increase their efficiency to best practice
standards, their transaction costs would still be significantly higher than those of
traditional banks providing much larger loans. For these banks the respective costs vary
in a range between 0.5 and 3 percent.209 According to this argument, charging interest
rates considerably higher than conventional banks is the only way for MFIs to generate
higher returns and hence successfully compete for capital.
202
See Tschach (2000), pp. 100 et sqq.
203
204
See M-Cril (2001b), p. 4.
205
See CIA (2004).
206
See MicroRate (2004).
207
In this paper, the term “low end” refers to the definition of the MBB (2003), p. 54. Loans worth less
than 20 percent of the respective country’s GDP per capita are described that way.
208
209
See M-Cril (2004a), p. 16.
40
6. Interest Rates
6.1. Setting the right Interest Rate
Before addressing the questions, to what extend MFIs can raise their interest rates
without putting the repayment rate or the social benefits of their customers at risk, a
basic model will be presented. This model will illustrate how a MFI should set their
rates in order to not only cover their costs, but also to generate an appropriate profit to
finance further growth and attract additional capital.
In 2002 CGAP revised its 1996 paper “Microcredit Interest Rates”,210 which outlines
the standard method of setting sustainable interest rates for commercially oriented
MFIs. According to this model the annual effective interest rate (I) should be calculated
as shown below:
TA + LL + CF + K − II
(1.) I=
1 − LL
With each variable being a decimal fraction of the average outstanding loan portfolio
whereby TA stands for the transaction costs as described above, LL represents the
annual loan loss and II stands for investment income, e.g. on liquid assets. The cost of
funds (CF) consist of the interest and administrative costs needed to obtain deposits and
commercial loans as well as of the imputed costs on equity due to inflation. K stands for
the capitalization rate, which represents the net real profit. Keeping this rate high is
important to finance the future growth of the loan portfolio. This can be either done
through investors attracted by high profitability or through borrowing. For the latter an
increase in equity is inevitable since it is required as a safety cushion by lenders.
Since this model ignores the timing of cash flows and does not take taxes into account,
it has to be regarded as fairly imprecise and hence should not be used for business
planning. Nevertheless, it can be used for an approximation of the interest rate that a
MFI would need to charge to provide its services as planned. In the following I will
210
See Rosenberg (2002), pp. 1 et sqq.
41
apply this model on a fictitious MFI working in a rural area of Latin America with low
end customers. In this setting it seems realistic to estimate transaction costs of 35
percent and loan loss rate of two percent.211 If funds were borrowed at commercial
terms, their costs can be assumed to equal at least 15 percent of the average outstanding
loan portfolio.212 Estimating the capitalization rate is more challenging. First the
targeted portfolio growth rate is set at 75 percent. This is slightly below the 75.1 percent
average annual portfolio growth between 2000 and 2002 found by a survey of 25
different MFIs based in Central and South America.213 If the extend to which the MFI
can leverage stays constant, the loan portfolios growth would be limited by the growth
rate of the equity. To express the capital needed for this growth as a share of the loan
portfolio, it is necessary to estimate the ratio between the equity and the outstanding
loan amount. According to the survey mentioned above, the loan portfolios of the 25
Latin American MFIs equal on average 2.15 times their equity.214 With this number, the
capital needed to increase the equity by 75 percent would corresponds to approximately
35 percent of outstanding loan amount (0.75/2.15). Finally the investment income has to
be estimated. Since liquid assets that are available short term do not generate high
returns, say five percent, it does not seem advisable for the MFI to hold more than a
quarter of its loan portfolio in this form. Hence the profit generated in this way would
equal 1.25 percent of the outstanding loan amount. Using these numbers, the equation to
calculate the annual effective interest rate reads as follows:
TA + LL + CF + K − II 0.35 + 0.02 + 0.15 + 0.35 − 0.0125

(2.) I= = = 0.875
1 − LL 1 − 0.02
As a result the MFI would need to charge an annual effective interest rate of
approximately 87.5 percent on its loans in order to sustainable provide its services and
finance its growth without depending on donor money. This rate might decrease once
the MFI matures, the growth slows down and cheaper funds become available, but it
will stay significantly higher than any rate charged by conventional banks.
211
MicroRate and IADB (2004), pp. 6 and 16.
212
See MicroRate and IADB (2004), p. 6,16 and 28.
213
Own calculation. See Appendix 4.
214
42
6.2. Can Micro-Entrepreneurs bear these Rates
Although most MFIs charge rates significantly below 87.5 percent, many critics have
strenuously argued against any rates exceeding those of traditional banks. Rosanna
Barbero of Oxfam labeled an interest rate of 52 percent charged by a Cambodian MFI
“ludicrous, evil and disgusting" and stated, that “[n]o business in the world can make a
profit at these interest rates.“215 The former finance minister of Bangladesh Shah Kibria
even categorized the 20 percent effective rate charged by the Grameen Bank as to
high.216 Many practitioners therefore believe in a strong negative correlation between
the interest rate and the demand for loans.217 Others have argued more generally that
concentrating on profitability and therefore charging high interest rates diverts MFIs
from serving the poorest.218
These views are still shared among many MFI managers, donor agencies and especially
investors and politicians. While the former are unwilling to charge interest rates for
funds they received “cheaply” (through grants or subsidized loans) and are worried
about undermining their social goals by charging higher rates of interest,219 the latter are
reluctant to invest for reasons stated above or impose interest caps to catch the attention
of the public by pretending to protect the poor from usury rates.220
In chapter 5.3. it has been described that micro-entrepreneurs, due to their smaller
capital endowment, have even better investment opportunities than big business. The
extend to which this is true has not yet been answered. An indication is the high
repayment rate observed within MFIs around the globe. If their customers capital yield
did not exceed the charged interest rate, how would they be able to repay? According to
Gibbons and Meehan customers of MFIs can generally generate returns of more than
100 percent on their invested capital221 and “[r]esearch in India, Kenya, and the
Philippines found that the average annual return on investments in microenterprises
215
See Kate and Roeun (2004).
216
See Hodson (2001), min. 11:00.
217
218
See Prisma (2002), p. 1.
219
See Schreiner (1997), p. 60; Khandker (1998) p. 106.
220
See Gross and de Silva (2002), p. 32; Jansson and Wenner (1997), p. 36 et sqq.; Campion (2002), p.
59.
221
43
ranged from 117 to 847 percent.”222. Schmidt and Tschach found the marginal
productivity of capital to be as high as 1000 percent for the smallest loans provided by
the Bolivian MFI Caja Los Andes.223 These findings are confirmed by the observation
of Rosenberg who found, while working as a microfinance consultant for ten years, he
never heard of a single MFI having problems to attract clients because interest rates
were too high.224
To get a better understanding of the investment opportunities of low income people in

developing countries, a typical example on how MFI clients invest their loans is as
follows:
Zobair is working as a rickshaw puller in Bangladesh. Like most of his colleagues he

does not own the rickshaw he is riding. Therefore he has to pay a daily rent of about
$0.30 to the owner. Since his average income of approximately $1.5 per day is hardly
enough to feed his family, he is not able to save the $100 necessary to buy a rickshaw
on his own. 225 If he could do so through obtaining a loan, his income would increase by
$0.30 every day, because he would not have to pay the rent for the rickshaw anymore.
Assuming an average of six working days per week, 226 and a life span of the rickshaw
of 5 years, his internal rate of return would equal 153.24 percent annually.227
Consequently any interest rate charged by a MFI would be advantageous to him as long
as it would not exceed 153.24 percent.228
6.3. Should the Interest Rate be subsidized anyway
Despite the fact that numerous micro-entrepreneurs are able to generate tremendous
returns on their investment, obviously not all are able to use capital in such a productive
way and therefore can not afford microcredit at commercial rates. In order to reach
these people as well, many MFIs continue to use donor money in order to keep their
interest rates low. But even if the problems related to subsidized credit as described in
222
See Helms and Reille (2004), p. 3.
223
See Schmidt and Tschach (2001), p. 6.
224
225
This examples draws on observations made by the author in Dhaka (Bangladesh) during 2003.
226
Obviously extended holidays are not a viable option in this surrounding.
227
Own calculation. See Appendix 6.
228
This result is only valid if the loan is repaid in daily instalments. For a weekly repayment schedule, the
interest rate charged by the MFI must not exceed 151.19 percent in order to still be beneficial for Zobair.
44
chapter 2.3. do not arise, it might still not be the most effective tool to help poor people
as will be illustrated in the following example:
A MFI faces two groups of potential clients, one with businesses able to generate a
return of 125 percent on borrowed capital and another with a possible returns of 50
percent. Assuming budget costs according to equation (2.) the institution needs to
charge an interest rate of 87.5 percent and therefore only serves the former group.
Supposed each group consists of 50 members demanding $100 loans, the net gains to
society (NGS) could be calculated as follows:
(3.) NGS = 50 × ($125 – $87.5) = $1,875
These gains would be due to the investments of the more profitable group which were
made possible through the loans provided by the MFI. The less profitable group would
not borrow, since their expected returns are not sufficient to pay for the interest. If the
interest rate would be lowered to 30 percent both groups would be able to generate net
gains and therefore borrow from the MFI. In order to provide loans at this rate, the
institution would need to raise additional capital from non commercial sources. The
NGS would be calculated as follows:
(4.) NGS = 50 × ($125 - $30) + 50 × ($50 - $30) + 100 × ($30 - $87.5) = 0
While the first terms represent the net gains to the respective groups, the last describes
the costs incurred in providing the loans. At a rate of 30 percent each loan would need
to be subsidized with $57.5. Hence the NGS actually fall after the introduction of the
subsidized loan. This is due to the fact that the less profitable group is encouraged to
invest in relatively unproductive businesses. In addition, future growth of the MFI could
be jeopardized due to scarce donor money which is needed to finance the interest rate
subsidy. Therefore it seems more advisable to continue to charge a rate of 87.5 percent
and spend the money used for subsidization on other programs, such as health care or
education.229
229
In Appendix 7 it will be shown that this result generally holds.
45
7. Empirical verification
7.1. Setting up a Sample
To see if the findings of the previous chapters hold, the effects which interest rates
charged by MFIs have on their performance will be analyzed in the following. Up to
now such a study does not exist mainly because of a lack of adequate data. Most MFIs
do not provide accurate information about the annual effective interest rate they charge
and therefore make an evaluation difficult.
In 2002, Rosenberg distinguished eight different categories on how microcredit interest

rates are quoted.230 These categories differ in several ways. On the contrary to
traditional banks for example, it is common for MFIs to state interest rates calculated on
a “flat” balance rather than on a declining one. This means that the total loan amount is
used to determine the interest rate, ignoring installments paid by the borrowers normally
on a weekly or monthly basis. In addition many MFIs charge a certain upfront fee prior
to the loan disbursement, require compulsory savings at a lower rate or state their
interest rate for semi annual terms only. On the one hand this is done to provide
numbers that are more meaningful to MFI customers who often lack the necessary math
skills to deal with compound interest, on the other hand it is done to circumvent interest
rate ceilings imposed by the government.231 Another problem is that most MFIs offer
different loan products without itemizing their respective shares to their total loan
portfolio. As a result it is not possible to calculate a weighted average even if the rate
stated by the respective MFI could be transformed into an effective interest rate.
Usually the portfolio yield is used as a proxy in order to make statements about the
interest rate charged by a certain MFI.232 It is generally “calculated by dividing total
cash financial revenue (all income generated by the loan portfolio, but not accrued
interest) by the period average gross portfolio.”233 The advantage of this method is that
even the hidden costs are considered. Nevertheless it also has a severe shortcoming by
not taking late or defaulted payments into account. Therefore the portfolio yield does
230
231
MicroRate (2002), p. 8.
232
See MicroRate (n.d.).
233
MicroRate and IADB (2003), p. 39.
46
not allow to draw conclusions regarding the correlation between the interest rate
charged by a MFI and its PAR.
7.2. Examining the Sample
Through the appearance of rating agencies specialized in the microfinance sector more
adequate information has become available in recent years. While MicroRate only
publishes the portfolio yield of rated MFIs, M-Cril, Microfinanza, Microserve and
Planet Rating actually provide information about the annual effective interest rate for at
least some of the MFIs they analyze. Although it is labelled differently from all of the
four institutions,234 the term describes what is “the highest income or yield that an
organisation can earn from its portfolio based on the terms of its loans.”235
Currently236 reports of 39 different MFIs from 20 countries providing accurate

information about the effective annual interest rate are available to the public. This
sample should be used to verify the findings of the previous chapters.237 Since a
comparison is made between the performances of MFIs based in different countries and
the ratings have been carried out in different years, several adjustments are necessary.
First the inflation of the respective country and the respective year(s)238 has to be taken
into account in order to only compare the real rates.239 In addition the average
outstanding loan amount per borrower is divided by the respective country’s GDP per
capita. Since it can be assumed that “only the poorer households will be willing to take
the smallest loans”240, this number can be used as a proxy for the poverty level.
Although the sample size is far to small to represent the microfinance sector as a whole,
and the results are statistically not significant, the findings can still be used to underline
the theoretical conclusions drawn in the previous chapters. In figure 5 the connection
234
M-Cril uses the name “annual percentage rate”. See e.g. M-Cril (2004a), p. 25. Microfinanza uses the
name “expected portfolio yield”. See e.g. Microfinanza (2002c), p. 25. Planet Rating uses the name
“annual effective interest rate”. See e.g. Planet Rating (2004d), p. 1. Microserve uses the name
“theoretical yield”. See Microserve (2003), p. 62.
235
See M-Cril (2004a), p. 25.
236
As of September 28th 2004.
237
See Appendix 8. For exchange rates see FXTOP (2004).
238
Where necessary a weighted average of the annual inflation rate was used. See Appendix 9.
239
This is done through the following formula: ir = (I – F) / (1 + F/100). While ir represents the real
annual effective interest rate, F represents the inflation rate.
240
Morduch (1998), p. 1572.
47
between the average loan size and the transaction costs as a share of the average loan
portfolio is illustrated.
Figure 5: Loan Size vs. Interest Rate241

Source: Own diagram.
100.00
90.00
80.00
70.00
Interest Rate
60.00
50.00
40.00
30.00
20.00
10.00
0.00
0 100 200 300 400 500 600
Loan Size
It can be seen that the interest rate is negative correlated to the loans size. This can be
explained by the relative higher transaction cost for smaller loans as described in
chapter 5.2.. In order to cover their costs, MFIs serving the low end market need to
charge higher rates to their customers than those organizations serving the better off
poor. Obviously there are several assumptions to this general finding. Especially
striking are the two MFIs with an average loan size of approximately five times their
countries GDP per capita which still high interest rates. This occurrence can be
explained by taking a closer look to the respective organizations. One was established
less than two years prior to its rating and therefore still bears a lot of start up costs,242
241
The equation for the regression line reads as follows: Y = -0.0219X + 36.5. The correlation coefficient
is 0.14.
242
See Microfinanza (2002b), p. 1.
48
the other managed to stay profitable while it almost quadrupled its loan portfolio in the
last two years.243
Figure 6: Interest Rate vs. PAR244

Source : Own diagram.
35
30
25
20
PAR
15
10
0
0 20 40 60 80 100 120
Interest Rate
In Figure 6 the crucial correlation between the interest rates charged by a MFIs and its
PAR245 is examined. According to the given sample, the view of traditional banks and
investors that a higher interest rate leads to a higher default rate does not hold.
Obviously one has to avoid to draw the opposite conclusion, namely that a high interest
rates decreases the PAR. The connection illustrated in figure 6 has to be interpreted as
follows. Since high interest rates are related to small loans, the low PAR for MFIs
charging high interest rates can actually be explained by the tremendous profitability of
small size investments. Despite the high rates their customers are even more likely to
repay.
243
See Planet Rating (2003b).
244
The equation for the regression line reads as follows: Y = -0.0768X + 6.8433. The correlation
coefficient is 0.235.
245
M-Cril only publishes the PAR for overdues greater than 60 days. Therefore these ratios are used as a
proxy for the industry standard of 30 days for some Asian MFIs.
49
Finally it has to be examined if charging high interest rates actually enables MFI to
generate higher returns. Although it can be expected that the combination of a low PAR
and a high interest rate leads to a high profitability, it still has to be checked if this is not
outdone by soaring transaction costs. Figure 7 illustrates the correlation between the
interest rate charged by a MFI and its financial self-sufficiency (FSS). The latter is the
“[r]atio of total income to total adjusted expenses for the year. Adjustments are made
for subsidised cost of funds (relative to market interest rate), equity (with respect to
inflation) and in-kind donations.”246 It can be seen that the regression line actually does
indicate a positive correlation between the interest rate and the profitability of a MFI.
Figure 7.: Interest Rate vs. FSS247

Source: Own diagram.248
180
160
140
120
100
FSS
80
60
40
20
0
0 20 40 60 80 100
Interest Rate
246
M-Cril (2004a), p. 53.
247
The equation for the regression line reads as follows: Y = 0.2839X + 89.01. The correlation coefficient
is 0.174.
248
Since the interest rate the customers of the MFI Foccas have to pay includes fees which are not passed
on to the institution, its interest rate in this diagram is set at 72.3 percent instead of the 107.15 percent
used for figure 6. See Planet Rating (2003b), p. 1.
50
This result does not necessarily disprove the findings of Stiglitz and Weiss since it can
be argued that MFIs simply do no increase their interest rates to the point where they
would maximize their expected returns. But if this would be true, why do MFIs not
charge higher rates of interest given the demand described in chapter 4.1 and 4.3? In
mature markets competition normally ensures prices not to exceed a certain level, but
since many MFIs still operate in a “seller’s market”249 this can not explain the findings
as described in figure 7. Therefore it has to be assumed that a combination of the
unwillingness of many microfinance practitioners to burden their customers with high
interest rates and the plain disbelief of traditional investors that micro-entrepreneurs can
bear those rates, is responsible for this occurrence.
249
See MicroRate and IADB (2003), p. 9.
51
8. Conclusions
It has been shown that MFIs are not only contributing significantly to the development
of the financial sector in their respective countries, but also that they play an important
role to eradicate poverty by providing much needed capital to low income people which
are able to generate tremendous returns on their investments.
The fact that the demand for microcredit is not met is mainly due to the view of most
for profit investors and traditional banks that offering financial services to poor people
can not be done profitable. Because of this conviction they hardly invest in the
microfinance sector. This does not have to be the case according to the findings of this
paper. Although faced with relatively high transaction costs MFIs are able to charge
interest rates at levels that fully recover their costs. Elizabeth Rhyne’s claim “that the
most financially viable programs differed from their less viable peers in their
willingness to set interest rates at levels that would fully recover costs”250 is backed by
the findings of this paper that high profitability is correlated to high interest rates.
Theoretical models based on the findings of Stiglitz and Weiss can not be used as a
justification to ration credit for the microfinance sector since the interest rate that
maximizes profits to the lender can be assumed to exceed 100 percent for many MFIs.
Nevertheless this rate is hardly charged, although it has been shown that it can be done.
The Mexican MFI Compartamos for example manages to keep its PAR as low as one
percent while charging an effective interest rate of more than 100 percent to
approximately 160,000 clients.251 In combination with this case, the conclusions drawn
from examining the sample of MFIs in chapter 7., the claim of Hulme and Mosley as
stated in the introduction can be considered as wrong. MFIs are in fact able to finance
rapid growth, stay profitable by charging corresponding interest rates and still have a
significantly positive impact on the poverty level of their clients. In the long run gains
in efficiency, economies of scale, a slowdown in growth and competition will ensure
interest rates drop as it has already been the case in countries like Bangladesh and parts
of Bolivia.252
250
See Rhyne (1998), p. 7.
251
See MicroRate (2004).
252
See Microrate and IADB (2003), p. 9.
52
According to a MicroRate survey many MFIs are more profitable than Citibank and also
generate a higher return on investment than commercial banks in their respective
countries.253 Investments companies like IMI or Blue Orchard will soon be able to
present a meaningful track record of their microfinance investments to potential
investors. Ultimately the capital markets can not ignore the facts proving that it actually
can be profitable to invest in the microfinance sector, but in order to raise money
quickly microfinance practitioners will have to continue to intensively promote their
cause not only to for profit investors, but also to donors and multilateral agencies like
the World Bank.
253
See MicroRate (2002), p. 10.
53
Appendix
Appendix 1: Average loan balance

Source: Data is available through the Mix Market (2004).
Loan Loan Number of Number of

Portfolio Portfolio borrowers Borrowers
Organization 2002 (US$) 2003 (US$) 2002 2003
2CM 1263602 1400438 3622 3708
ACF 955503 1611401 285 370
ACLEDA 26846703 39391301 82598 98905
ACME 1460881 1714844 4283 4600
ADIM 369065 407798 1122 1395
AFK 933306 1706577 250 467
AgroInvest 4684249 9697411 5208 9629
Al Amana 15593277 28677666 78114 101610
AMSSF/MC 612167 1040756 6183 6886
AREGAK 3285273 3987011 11841 14377
AVFS 214331 269819 1883 2866
BancoSol 83629049 91175000 42290 56707
BESA 10563980 15114430 4488 5061
BPR AK 613362 876130 1730 3879
BPR BMMS 133949 237946 1755 1779
BRI 1344006170 1720072773 3056103 3100358
BZMF 1592508 1922097 1250 1331
CBDIBA 216587 242465 5764 2877
CCA 2146235 4582302 4070 6585
CCCP 447534 851678 6265 9450
CEP 3795400 5261957 32291 42132
CERUDEB 25093643 34873228 34490 44796
CMEDFI 227674 250244 3467 3781
CMM - Bogota 4836000 8135968 15635 22038
CMMB 34880 56964 42 190
COAC Maquita 870084 1855718 6603 7732
Cushunchic
CODES 280843 263091 60 60
CODESARROLLO 6714007 12935951 4391 6896
Constanta 2943822 3536047 16134 18588
COOPEC CAMEC 7152 29821 92 77
MN
Crear - Tacna 3891116 4636094 3671 4948
CREDIT 642094 81838 7532 8097
CRYSTAL FUND 366456 421403 1379 1061
DBACD 3473701 3876526 12812 19606
ECLOF - ECU 1154292 728312 860 416
ECLOF - MAL 441734 407227 1118 1500
EKI 11833244 19245751 8999 13323
EMT 4481589 5765281 84781 92173
ESED 8579460 6834742 22790 20035
54
Eshet 185741 462569 3308 6540
Faulu - KEN 9027332 7206344 17463 15000
FDL 12503027 16545332 21306 25106
FIE 35818903 41597315 26468 33100
FINADEV 5512586 9770323 12775 14709
Finance Salone 211312 434298 2225 7159
Finca - TAN 1293430 1854834 20648 27499
Finca - UGA 2451703 2798869 35610 36912
FINCORP 4761288 10236896 941 858
FJN 5473563 8037662 8107 11133
FMFB 308158 1188896 713 3558
FMM - 6355518 10227000 25814 42464
Bucaramanga
FODEM 739181 939824 1909 2501
Fundaci 898561 1883446 5911 9464
ESPOIR
FUNDESER 798907 1373113 4072 5065
Gasha 323748 413742 5504 6423
GGLS Save the 64235 137957 1291 2362
Children
GK 56986 166971 951 2718
HKL 1363365 1420357 6648 5372
HOPE 402799 603488 1098 1562
IAMD 42132 56550 2780 2772
IDECE 21312 39453 150 232
IDF 2031944 2626382 31003 36580
IMCEC - Dakar 254759 688449 1018 2983
IMCEC - Thies 199799 571122 1164 1261
ISSIA 221615 246792 1409 1698
JMCC 1962355 2609723 1471 2333
KAFC 21710638 29241051 24850 32097
KAMURJ 1003935 1411258 5559 5691
Kashf 2355965 6271498 29655 59389
KMBI 721409 1626666 11973 27266
KPSCA 109299 128063 362 794
K-Rep 14490447 20699963 38739 45379
KSCS 18978 43740 140 297
KVT 44075 70621 241 373
LAPO 922478 1194633 18740 19139
MEC ADEFAP 27788 69248 198 202
MEC Bosangani 14357 31086 364 540
MEDF 104113 136257 1278 1184
Meklit 233170 252232 2084 3577
Metemamen 22123 57778 943 1501
MFSC 109261 171090 511 687
MIKRA 2951028 5008784 4145 6095
MIKROFIN 9560502 18380263 5633 7426
Miselini 737387 1026639 10182 11431
MRFC 11475440 9133130 163000 180000
Mushuc Runa 2089076 5418325 3139 6232
Nirdhan 2886777 3016171 29589 27457
OCSSC 5245186 7658413 42157 6215o
55
Otiv Diana 95992 638422 229 1073
Otiv Sambava 188094 437974 2002 1442
Otiv Tana 66465 673175 337 1269
Partner 9976448 15321304 7139 11935
PCA 6878257 6885926 63113 58147
PEACE 420746 627295 4192 5428
PEDF 164399 254233 2357 3340
Piyeli 809447 1206656 8674 4745
PRESTANIC 2827502 3540367 1477 2605
PRIDE - MAL 991888 854631 5376 5601
PRIZMA 3881581 6838978 8112 10968
ProMujer - 1006871 1424437 10436 13047
Nicaragua
PTF 891566 1068881 8500 9070
RBST 818594 1058115 619 723
REMECU 1381705 1483471 10330 13996
RUSCA 60887 100820 454 994
SCSCS 89423 157472 873 1007
SFPI 709497 903556 7728 9552
Sidama 934260 1011798 10267 11346
SPBD 117807 186029 647 1740
Sunlink 819138 1056823 3401 3833
Sunrise 5412366 8782868 4560 7256
TEBA 108032426 176300111 163021 157776
TIAVO 281978 838905 2049 459
TPC 1140429 2267148 22869 31668
TSPI 4650989 5383755 49649 75617
UNICECAM 3442843 5943804 16039 19031
Wasasa 230657 274908 2850 3728
Wisdom 1306066 1404463 10524 12054
XacBank 4910098 9829503 11063 18610
Zakoura 15907288 12444768 103720 118980
Appendix 2: Portfolio at Risk

Organization PAR 2002

ABA 2.02%
ACEP 4.64%
ACLEDA 1.75%
ACODEP 4.52%
ACSI 2.09%
Al Amana 0.10%
Apoyo 4.83%
Integral
AREGAK 6.92%
Banco 5.00%
Solidario
BancoSol 6.60%
BASIX 12.96%
56
BRI 4.37%
BURO 3.50%
Tangail
CEP 2.00%
CERUDEB 1.03%
CMAC - 5.67%
Sullana
CMM - 1.76%
Bogota
Compartamos 1.11%
Constanta 3.04%
Credi Fe 2.12%
CREDIAMIGO 4.09%
DBACD 0.10%
EBS 8.47%
EMT 0.10%
ESED 13.11%
FADES 23.11%
Faulu - KEN 2.46%
Faulu - UGA 0.96%
FDL 2.12%
FECECAM 4.28%
FED 4.36%
FIE 5.98%
FINADEV 0.21%
Finamerica 11.33%
Finca - TAN 0.00%
Finca - UGA 2.97%
FMM - 0.94%
Bucaramanga
FMM - 0.88%
Popayan
FONDEP 0.13%
FORA 0.64%
Genesis 11.97%
Empresarial
IDF 0.17%
KAFC 1.06%
Kashf 0.00%
KMBI 1.28%
K-Rep 2.29%
MiBanco 3.09%
MRFC 17.42%
Nirdhan 3.73%
PADME 0.79%
PAMECAS 2.84%
PCA 3.79%
PRIDE - TAN 0.18%
ProMujer - 0.73%
Nicaragua
RCPB 6.00%
REMECU 1.57%
SHARE 0.00%
57
Soluci 1.82%
Spandana 0.14%
TEBA 1.06%
TSPI 3.55%
UMU 1.25%
UNICECAM 4.05%
Urwego 2.90%
UWFT 3.63%
WAGES 7.36%
WWB - 2.35%
Medellin
XacBank 0.61%
Zakoura 0.95%
Appendix 3: Transaction Costs

Transaction
Organization Costs
Acci Rural 11.54%
ACEP 8.58%
ACLEDA 24.30%
ACODEP 29.20%
ACSI 9.24%
Al Amana 25.76%
AREGAK 28.56%
AssEF 19.19%
Banco 18.26%
Solidario
BancoSol 12.10%
BASIX 13.17%
BRI 13.53%
BURO 20.53%
Tangail
CEP 17.59%
CERUDEB 51.09%
CMAC - 17.84%
Sullana
CMM - 20.89%
Bogota
Compartamos 33.41%
Constanta 45.97%
Credi Fe 19.78%
CREDIAMIGO 25.25%
DBACD 17.42%
EBS 23.77%
EMT 32.20%
ESED 13.43%
FADES 16.73%
FAMA 24.36%
58
Faulu - KEN 22.53%
Faulu - UGA 49.62%
FDL 17.26%
FECECAM 25.87%
FED 40.83%
FIE 11.25%
Finamerica 15.63%
Finca - TAN 107.53%
Finca - UGA 90.96%
FMM - 19.25%
Bucaramanga
FMM - 11.12%
Popayan
FONDEP 54.77%
FORA 34.81%
Genesis 16.26%
Empresarial
IDF 16.95%
K-Rep 19.09%
LAPO 35.11%
MiBanco 24.56%
Nirdhan 13.25%
NWTF 31.09%
OCSSC 11.55%
PADME 11.31%
PAMECAS 17.05%
PCA 16.70%
PRIDE - TAN 42.73%
ProMujer - 50.78%
Nicaragua
RCPB 20.59%
SHARE 23.08%
Sidama 26.62%
Soluci 29.06%
Spandana 6.41%
TEBA 12.13%
TSPI 38.98%
UMU 40.23%
UNICECAM 101.20%
Urwego 74.37%
Wisdom 19.06%
WWB - 17.03%
Medellin
XacBank 41.44%
Zakoura 18.81%
59
Appendix 4: Portfolio Growth
Total Loan Total Loan

Portfolio in Portfolio in
Organization 2000 2002
ACODEP 5,889,394 7,258,487
Adelante 4,327 88,594
ADRI 1,514,681 2,591,240
AgroCapital 11,100,088 12,018,280
Banco Solidario 39,632,165 103,420,000
BancoSol 78,031,172 83,629,049
CMAC - Sullana 14,596,365 28,055,720
COAC Maquita 348,443 870,084
Cushunchic
CODESARROLLO 1,374,801 6,714,007
Compartamos 10,804,279 41,825,248
Crear - Tacna 3,778,816 3,891,116
Credi Fe 781,616 9,393,936
ECLOF - ECU 179,247 1,154,292
FADES 11,948,814 15,501,578
FAMA 6,201,411 8,835,134
FIE 22,524,645 35,818,903
Finamerica 16,575,104 16,097,113
FINCOMUN 3,278,938 5,696,556
FMM - Popayan 6,241,821 12,212,867
FONDECO 3,456,625 5,101,801
Genesis 11,154,234 17,746,288
Empresarial
MiBanco 36,964,072 95,873,333
Mushuc Runa 90,737 2,089,076
ProMujer - 426,541 1,006,871
Nicaragua
WWB - Medellin 2,891,207 4,580,998
Appendix 5: Portfolio vs. Equity

Loan
Organization Portfolio Equity
ACODEP 7,258,487 1,921,447
Adelante 88,594 72,973
ADRI 2,591,240 781,477
AgroCapital 12,018,280 10,766,101
Banco Solidario 103,420,000 12,961,000
BancoSol 83,629,049 15,299,415
CMAC - Sullana 28,055,720 6,210,291
60
COAC Maquita 870,084 260,331
Cushunchic
CODESARROLLO 6,714,007 1,285,103
Compartamos 41,825,248 18,350,446
Crear - Tacna 3,891,116 1,016,912
Credi Fe 9,393,936 863,848
ECLOF - ECU 1,154,292 459,226
FADES 15,501,578 4,138,972
FAMA 8,835,134 6,377,663
FIE 35,818,903 5,360,484
Finamerica 16,097,113 3,817,960
FINCOMUN 5,696,556 1,042,241
FMM - Popayan 12,212,867 8,510,494
FONDECO 5,101,801 1,658,075
Genesis 17,746,288 4,765,816
Empresarial
MiBanco 95,873,333 24,261,889
Mushuc Runa 2,089,076 434,311
ProMujer - 1,006,871 1,196,015
Nicaragua
WWB - Medellin 4,580,998 2,213,249
Appendix 6: Internal Rate of Return

Source: Excel (German Version) calculation based on own data.
A B C D E F
Interest Rate /
Internal Rate of
1 Date Cash Flow Return Balance Interest Principal
2
3 01.01.2004 -100 153.24% 100 0.25489547 0.04510453
4 02.01.2004 0.3 99.9548955 0.25489547 0.04510453
5 03.01.2004 0.3 99.909676 0.2547805 0.0452195
6 04.01.2004 0.3 99.8643412 0.25466524 0.04533476
7 05.01.2004 0.3 99.8188909 0.25454968 0.04545032
8 06.01.2004 0.3 99.7733247 0.25443383 0.04556617
9 08.01.2004 0.3 99.9826083 0.50928361 -0.2092836
10 09.01.2004 0.3 99.9374595 0.25485114 0.04514886
... … … … … … …
… … … … … … …
… … … … … … …
1562 23.12.2008 0.3 1.77951388 0.00528711 0.29471289
1563 25.12.2008 0.3 1.48859724 0.00908336 0.29091664
1564 26.12.2008 0.3 1.19239161 0.00379437 0.29620563
1565 27.12.2008 0.3 0.89543096 0.00303935 0.29696065
1566 28.12.2008 0.3 0.59771337 0.00228241 0.29771759
1567 29.12.2008 0.3 0.29923692 0.00152354 0.29847646
1568 30.12.2008 0.3 -3.434E-07 0.00076274 0.29923726
61
The formula in the square C3 reads as follows:
“XINTZINSFUSS(B3:B1568;A3:A1568;1.5)”.
Appendix 7: Subsidized Interest Rates and the Net Gains to Society

Source:Own calculations
For simplicity only two groups of potential clients are distinguished. This is possible
since using a continuum of potential clients would lead to the same results. In addition it
is assumed that the amount of every loan (L) is equal and that all clients invest the
whole loan amount. Group H consist of NH potential clients with a rate of return (rH) on
their invested capital higher than the cost recovering interest rate charged by the MFI
(iC). Group L consists of NL potential clients with a rate of return (rL) on their invested
capital lower than iC. If the MFI charges iC, the NGS can be calculated as follows:
NGSC = NH × (rH - iC) × L
Since rH is bigger than iH (rH > iC) according to the definition presented above, the term
NGSH must be positive as long as NH does not equal zero. If the MFI introduces a
subsidised interest rate (iS) lower than rL, the NGS can be calculated as follows:
(1.) NGSS = NH × (rH - iS) × L + NL× (rL - iS) × L + (NH + NL) × (iS - iC) × L
(2.) NGSS = NH × (rH- iC) × L + NL× (rL - iC) × L
The term (NH + NL) × (iS - iC) × L describes the amount of money that is needed in order
to subsidize the interest rate to the level iS. By setting up an inequation, it can be
examined under which conditions the NGSS are bigger than the NGSC:
(3.) NGSS > NGSC
(4.) NH × (rH- iC) × L + NL× (rL - iC) × L > NH × (rH - iC) × L
(5.) NL× (rL - iC) × L > 0
(6.) r L > iC
62
So the NGSS could only be bigger than the NGSC, if equation 6. holds. This is
impossible since it violated the definitions presented above. Therefore the introduction
of subsidized interest rates is always accompanied with a drop in the NGS.
Appendix 8: Interest Rate vs. Loan Size vs. FSS vs. PAR.
Loan Size
Real (divided by
Interest the GDP
Organization Country Rate per Capita) FSS PAR
Kyrgyz
BTFF Republic 38.03 482.60 148.7 6.98
Besa
Foundation Albania 21.84 160.76 68.4 2.60
RFF Albania 11.98 57.83 47.64 2.77
PSHM Albania 21.94 0.00 57.58 1.98
Mi-Bospo Bosnia 29.74 54.99 126.1 0.20
Prizma Bosnia 34.74 35.69 103 0.64
Agroinvest Serbia 22.01 44.01 87.5 0.20
KCLF Kazakhstan 57.13 17.13 86.5 0.90
107.16
Foccas Uganda (72.3) 15.50 58.4 2.9
ACEP Senegal 32.80 209.41 164.3 1
Padme Benin 27.15 135.75 166.7 0.8
Papme Benin 30.86 536.59 140.5 2.4
Vital Finance Benin 26.76 93.94 101.5 1.7
Finadev Benin 17.38 148.50 102.4 2.1
ABA Egypt 25.79 16.13 116.8 8.8
ASBA Egypt 25.97 17.02 125.2 6.8
DBACD Egypt 24.90 16.43 107.3 0
SBACD Egypt 25.00 17.34 98.2 6.7
AMSSF Morocco 69.26 7.87 130.6 0.4
Fondep Morocco 51.99 6.50 88.9 0.71
Zakoura Morocco 44.14 9.00 98 0.06
ENDA Tunisia 40.08 13.51 110 1.02
BSFL India 19.54 32.69 85.6 9.9
Share India 34.26 14.40 95.1 0
Spandana India 29.42 16.18 136.7 0.26
SWC India 18.64 26.26 42 30.36
SKS India 22.48 19.12 57.8 0
Grama Vidiya India 31.76 12.21 76 1.8
Sneha India 34.51 14.33 93.3 0
Buro Bangladesh 32.06 18.82 109.3 1.7
Upap Pakistan 20.73 81.83 75.7 0.3
Seeds Sri Lanka 10.04 10.88 60.5 28.7
EMT Cambodia 43.24 16.76 101.6 0.1
TPC Cambodia 44.70 20.35 83.2 2.7
63
WTF Phillippines 58.16 10.95 94.1 7.4
TSKI Phillippines 57.94 7.77 96 7.9
Cacja Ecuador 8.62 61.89 94.60 8.97
ACME Haiti 60.43 69.34 116.85 4.50
Grupo Cama Mexico 89.61 2.67 107.17 2.88
64
Appendix 9: Inflation vs. GDP per Capita
Source: IMF (2004).
Country Subject Description Units Scale 2000 2001 2002 2003 2004
Albania Gross domestic product per capita, current prices US dollars Units 1083.988 1238.206 1396.172 1757.778 2229.712
Albania Inflation, annual percent change Percent 0.0 3.1 5.2 2.4 3.4
Bangladesh Gross domestic product per capita, current prices US dollars Units 329.310 327.980 344.494 369.495 393.717
Bangladesh Inflation, annual percent change Percent 2.2 1.5 3.8 5.4 6.4
Benin Gross domestic product per capita, current prices US dollars Units 361.340 368.213 405.951 494.725 560.129
Benin Inflation, annual percent change Percent 4.2 4.0 2.4 1.5 2.6
Bosnia and Herzegovina Gross domestic product per capita, current prices US dollars Units 1255.837 1321.429 1466.090 1807.392 2070.508
Bosnia and Herzegovina Inflation, annual percent change Percent 5.0 3.2 0.3 0.2 0.9
Cambodia Gross domestic product per capita, current prices US dollars Units 276.413 280.352 296.577 305.940 321.247
Cambodia Inflation, annual percent change Percent -0.8 0.2 3.3 1.2 2.0
Ecuador Gross domestic product per capita, current prices US dollars Units 1227.711 1590.267 1804.362 1957.183 2082.156
Ecuador Inflation, annual percent change Percent -7.7 37.7 12.6 7.9 3.2
Egypt Gross domestic product per capita, current prices US dollars Units 1550.982 1461.431 1278.462 1188.060 1083.158
Egypt Inflation, annual percent change Percent 2.8 2.4 2.4 3.2 5.2
India Gross domestic product per capita, current prices US dollars Units 454.206 458.849 472.915 542.554 602.625
India Inflation, annual percent change Percent 4.0 3.8 4.3 3.8 4.7
Kazakhstan Gross domestic product per capita, current prices US dollars Units 1236.159 1490.946 1655.148 2000.598 2579.554
Kazakhstan Inflation, annual percent change Percent 13.4 8.3 5.9 6.4 6.8
Kyrgyz Republic Gross domestic product per capita, current prices US dollars Units 278.256 306.130 321.079 349.632 380.637
Kyrgyz Republic Inflation, annual percent change Percent 18.7 6.9 2.1 3.1 4.5
65
Mexico Gross domestic product per capita, current prices US dollars Units 5957.486 6274.468 6425.203 6111.754 6377.064
Mexico Inflation, annual percent change Percent 9.5 6.4 5.0 4.5 4.4
Morocco Gross domestic product per capita, current prices US dollars Units 1161.302 1162.154 1199.584 1432.725 1541.041
Morocco Inflation, annual percent change Percent 1.9 0.6 2.8 1.2 2.0
Pakistan Gross domestic product per capita, current prices US dollars Units 437.381 400.356 440.471 492.913 538.120
Pakistan Inflation, annual percent change Percent 4.4 3.1 3.2 2.9 4.6
Philippines Gross domestic product per capita, current prices US dollars Units 979.423 900.225 950.707 963.765 1018.710
Philippines Inflation, annual percent change Percent 4.3 6.1 3.1 3.0 5.4
Russia Inflation, annual percent change Percent 20.8 21.5 15.8 13.7 10.3
Senegal Gross domestic product per capita, current prices US dollars Units 478.704 474.460 507.408 634.171 714.622
Senegal Inflation, annual percent change Percent 0.9 3.0 2.3 -0.0 0.8
Serbia and Montenegro Gross domestic product per capita, current prices US dollars Units 1031.263 1389.384 1882.036 2491.799 2795.805
Serbia and Montenegro Inflation, annual percent change Percent 69.9 91.1 21.2 11.3 7.9
Sri Lanka Gross domestic product per capita, current prices US dollars Units 846.811 796.025 828.256 904.330 982.466
Sri Lanka Inflation, annual percent change Percent 6.2 14.2 9.6 6.3 6.4
Tunisia Gross domestic product per capita, current prices US dollars Units 2034.360 2065.140 2149.421 2534.823 2881.273
Tunisia Inflation, annual percent change Percent 3.0 1.9 2.8 2.8 3.4
Uganda Gross domestic product per capita, current prices US dollars Units 293.404 249.682 279.587 280.802 287.204
Uganda Inflation, annual percent change Percent 4.5 -2.0 5.7 5.1 3.5
66
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The Impact and Outreach of Microfinance Institutions:

The Effect of Interest Rates

Revised November 2004

2. The Development of Microfinance ........................................................ 7

3. The Impact of Microcredit ................................................................... 13

4. Microcredit Outreach ........................................................................... 24

6. Interest Rates ......................................................................................... 41

7. Empirical verification ........................................................................... 46

Internet References ................................................................................... 71

Other Sources ............................................................................................ 78

Figure 1: Expected Bank Return and the Interest Rate ........................................... 32

2.1. What is Microfinance?

2.2. The Origin of Microfinance

The credit cooperatives21 created in Germany in 1847 by Friedrich Wilhelm Raiffeisen

2.3. Microfinance after the Second World War

2.4. Microfinance Today

In February 1997 more than 2,900 policymakers, microfinance practitioners and

3.1. Microcredit and the Millennium Development Goals

3.2. The Eradication of extreme Poverty and Hunger

3.3. Achievement of universal primary Education

Microcredit programs mainly contribute to the second MDG by increasing families

3.4. Promote gender Equality and empower Women

3.5. Reduce Child Mortality and improve Maternal Health

3.6. Combat HIV/AIDS, Malaria and other diseases

3.7. Ensure environmental Sustainability

Today climate change is considered as the major environmental problem.103 The

3.8. Develop a global Partnership for Development

4.1. The Demand for Microcredit

Marguerite Robinson calculates the demand as follows: “Assuming five people to a

4.2. The Supply of Microcredit

4.3. Meeting the Demand

4.4. Microfinance and the Capital Markets

5.1. The imperfect Information Paradigm

Figure 1: Expected Bank Return and the Interest Rate

5.2. Adaptation to the Microfinance Sector

Figure 2: The extended Model

R(i)large Transaction costs

INTEREST RATE I(l)* I(s)*

6.1. Setting the right Interest Rate

TA + LL + CF + K − II 0.35 + 0.02 + 0.15 + 0.35 − 0.0125

To get a better understanding of the investment opportunities of low income people in

Zobair is working as a rickshaw puller in Bangladesh. Like most of his colleagues he

6.3. Should the Interest Rate be subsidized anyway

(3.) NGS = 50 × ($125 – $87.5) = $1,875

(4.) NGS = 50 × ($125 - $30) + 50 × ($50 - $30) + 100 × ($30 - $87.5) = 0

7.1. Setting up a Sample

In 2002, Rosenberg distinguished eight different categories on how microcredit interest

7.2. Examining the Sample

Currently236 reports of 39 different MFIs from 20 countries providing accurate

Figure 5: Loan Size vs. Interest Rate241

Figure 6: Interest Rate vs. PAR244

Figure 7.: Interest Rate vs. FSS247

Appendix 1: Average loan balance

Loan Loan Number of Number of

Appendix 2: Portfolio at Risk

Organization PAR 2002

Appendix 3: Transaction Costs

Total Loan Total Loan

Appendix 5: Portfolio vs. Equity

Appendix 6: Internal Rate of Return

Appendix 7: Subsidized Interest Rates and the Net Gains to Society

NGSC = NH × (rH - iC) × L

(2.) NGSS = NH × (rH- iC) × L + NL× (rL - iC) × L

(3.) NGSS > NGSC