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The Future of Microfinance Interest Rates
The Future of Microfinance Interest Rates
Although the intentions of MFIs are good, a constant problem found at the core of all
institutions is the issue of interest rates. To best understand how to handle such a
delicate aspect of the Microfinance process, one must first understand both sides of
the argument.
The Hype
Since its creation, Microfinance has met opposition on the front of interest rates from
a vast array of poverty fighters. Essentially, the argument against having interest
rates can be summed up in about three points.
While all these arguments point out large deficiencies in the lending system, the
rebuttal to the argument against interest rates can be summarized by the following
tenets.
Looking for the greatest amount of growth and productivity, three basic interest rate
methods that should be considered are: fixed interest rates, exponentially increasing
interest rates, and exponentially decreasing interest rates. But to understand why
there should be a change in the interest rate method, some historical background
must be addressed. Back when Muhammad Yunus pioneered the beginnings of the
Grameen Bank, in order to make payments and all financial transactions between
borrowers and lenders as simple as possible, a simple fixed interest rate was placed
upon all dealings. In retrospect of this decision, while many of the borrowers who
received funding were able to improve their social conditions, could this process have
been accelerated by use of a different interest rate structure?
Scenario Controls:
Conditions for this scenario include that all transactions maintain a 10% interest
rate. Therefore, when applied to a progression of annual incomes, the amount of
money paid to the Microfinance Institutions are as such:
Benefits:
Disadvantages:
While charging a standard rate of 10% on each loan allows borrowers to take
out loans beneath the average rates commercial banks charge, the amount of
money that can be saved/focused into either improving social conditions or
financing businesses is great enough to have a significant effect, and
therefore hurts borrowers by holding them back from using this money.
So while this approach may be the easiest to apply, in the long term borrowers will
be paying more than as compared to those other types of interest rate strategies.
Benefits:
The draw to this type of interest rate method would be that while most
commercial business models would start off borrowers at a high interest rate,
this approach would give lendees a chance to rapidly expand before standard
interest rates were imposed.
Another plus is that this method gradually builds into the regular interest
rates that most microfinance businesses charge, eventually leading into the
standard commercial rates. Ultimately, this would ease borrowers into the
demands of the financial world.
In terms of revenue, both the borrower and microfinance institution will be
making gains, with the MFI still making over $400 and the borrower gaining
more than $70 of spending power.
Disadvantages:
Benefits:
Since the hardest part of this method is endured during the beginning of the
cycle (ranging from $0-$500), after this first stage is complete, every
transaction thereafter will require less and less money while still borrowing
more and more money.
Essentially, this puts more money in the pockets of borrowers, allowing them
to make decisions requiring more money than previously available.
The motivational factor associated with this form of interest is that it also
gives borrowers a goal to strive for, as with every improvement in credit and
the more money allowed to be borrowed, less money has to be paid in
interest.
A constant problem Microfinance Institutions meet is that of resistance from a
rural community. By establishing such a low interest rate, MFIs can gain the
popularity and trust of lenders by offering desirable options.
Disadvantages:
Financially, this method severely cuts back the amount of money that
Microfinance Institutions can extract from their borrowers to finance other
services.
Such other services as communications, agricultural help, electrical services
and counseling are restricted because of this cut, as the finances are no
longer available.
With this analysis of interest rates, it can logically be reasoned that for MFIs looking
to give floundering businesses the opportunity to rapidly expand their
products/services by way of their own knowledge, a business model incorporating an
exponentially decreasing interest rate is the most effective. As for a situation in
which MFI supervisors feel that the community in which they are rooted lacks a
certain focus, or is working towards an unrewarding objective, an exponentially
increasing model is most appropriate. But, for MFIs looking to expand their own
services to communities with problems both within the businesses and foundational
structure of the society, the fixed interest rate is the most logical in order to allow for
the greatest amount of social effect.
Ideally, these three do not have to be strictly enforced with each specific
Microfinance Institution. In an evolutionary sense, all three could be incorporated
through the eventual growth of the facility from newly established lending source to
a well known source of financing and counseling. Borrowers would witness the
transformation of such institutions from a fixed interest rate, to a increasing interest
rate and finally to a decreasing interest rate. While such technicalities as when and
for whom these changes would occur for might cause divisions within a MFI, if a
graduation system is employed to allow borrowers to move from one system to
another (in the order of fixed, increasing and then decreasing), business owners
would remain with such financial sources for longer periods of time while also holding
in mind the goal of achieving further financial independence.
I hope that this article helps to expose the intentions, benefits and disadvantages of
interest rates, and that Microfinance Institutions will better adapt their strategies in
order to further advance the financial stability of rural businesses.
(*disclaimer the equations used were merely examples. The Revelationist is not
responsible for interest rate advice.)
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