The World of Microfinance

Improving the life of poor people through loans
By Heide B. Malhotra, Epoch Times
December 12, 2013 Updated: December 12, 2013

Microfinance loans have been around for many years. However they have evolved into a different format recently, a more benign one.

In the past, a borrower who had little or no funds had to borrow from moneylenders who generally charged exorbitant fees and were ruthless when it was time to pay back the loan.

Then the change: In 1976, Nobel Peace Prize winner Muhammad Yunus, a professor and head of the rural economics program at a Bangladesh university, launched a program that would provide banking services for poor men and women.

The intent was to stop the exploitation by loan sharks and create opportunities for unemployed and disadvantaged people in rural areas. The program was successful and today more affordable financing is available to the working poor, not just in Bangladesh, but worldwide.

Devex, a microfinance information hub, said the sector has become an established form of lending to the disadvantaged worldwide.

Microfinance is provided by three different sources: “formal institutions like rural banks and cooperatives, semiformal ones such as nongovernmental organizations, and informal groups including moneylenders,” said Devex.

Microfinance Interest Rates

Although microfinance loan applications have taken off over the years, a misconception exists concerning the interest rates charged on these loans. Interest rates charged by microfinance lenders are by no means low—often higher than bank loans, but not as high as the rates loan sharks charge.

According to a 2010 Huffington Post article, “While not all moneylenders by any means are the evil loan sharks of legend, they do generally charge rates far in excess of those charged by microlenders.”

In June 2013, CGAP, a consulting firm, published a report “Microcredit Interest Rates and Their Determinants: 2004–2011.” The authors said that microfinance institution interest rates are much higher than rates charged by regular banks.

The reason according to the CGAP report, “These rates are higher, often much higher, than normal bank rates, mainly because it inevitably costs more to lend and collect a given amount through thousands of tiny loans than to lend and collect the same amount in a few large loans. Higher administrative costs have to be covered by higher interest rates.”

Opponents of high rates state this justification is another form of exploitation of the poor who have little or no bargaining power. The opponents think microfinancing is just another outlet of the private sector to make a profit, as opposed to the nonprofit label, which is often advertised.

A 2010 article by the Huffington Post states several factors that determine interest rates. First, how big is the loan? Secondly, what is the highest caseload a loan officer can handle and what is the salary of a loan officer? Lastly, rates also depend on the country where the microloan is disbursed.

For example, in a small developing country, such as Bolivia, salaries are lower and thus the cost is lower, while in a larger nation where the loan officer’s salary is higher, the interest rate is conversely higher.

The CGAP report concurs and states interest “rates vary more widely in Africa and Latin America than in other regions. Also, we notice that rates are substantially lower in South Asia than elsewhere.”

Besides, funding costs also affect interest rates. The cost for funds has risen over the years because governments are limiting subsidies for microloans. Furthermore, to serve their customers the microlenders have to borrow in the market and market rates have risen in many developing countries recently.

Global Growth

In August 2012, Devex published a list of the top 10 microfinance institutions based on number of employees. The largest was Dhaka in Bangladesh with 44,306 employees and more than 5 million borrowers in 2011. In the top 10, three lenders are located in Bangladesh, four in India and one in each of Mexico, Vietnam, and Cambodia.

According to the “Microfinance Market Outlook 2013,” published by responsAbility Social Investments AG in Switzerland, the microfinance sector grew by 20 percent in 2012 and is expected to maintain this growth rate during 2013.

According to the “Microfinance Barometer 2013” publication by Convergences, microfinance has “the potential to contribute to the social, economic and financial inclusion of the worse-off populations.”

Defaulting on Microloans
With an increase in the cost of the loans, the CGAP report stated borrowers have been defaulting on their loans in large numbers in Mexico and India. Other regions also experienced borrower defaults, but not to the extent as the two aforementioned nations.

Additionally, “for-profit microlenders have had higher loan losses than nonprofits do,” according to CGAP. The reason could be that for-profit lenders take on riskier loans than nonprofits.

Microloan researchers state that collecting on defaulted loans is very difficult, as only very few microloans are backed by collateral. Also, if there is collateral, it mostly doesn’t cover the collection expenses. Therefore, the majority of defaulted loans are written off.

Despite defaults and risks, the microfinance sector will continue to grow. With 2.5 billion, or 35 percent of adults in the world still lacking access to a bank account, growth is sure to come about.

“To increase access to financial services worldwide, microfinance is using innovative products and delivery channels, such as mobile banking, and working to increase the capacities of service providers,” said the Convergences report.