The Other Side of the Interest Rate Argument
After reading Neil MacFarquhar’s article “Banks Making Big Profits from Tiny Loans”, I was shocked to hear about how exorbitant are the interest rates that some microfinance institutions (MFIs) around the world are charging their borrowers and saddened to hear that the focus of these institutions has clearly drifted from helping the poor. However, in my experience, founding Wokai, a China-focused microfinance organization, I have to point out that high interest rates is not a universal problem. In fact, China is facing the opposite issue: interest rates charged by MFIs are too low.
Wokai’s partner MFIs (our “Field Partners”) charge rates are well within the range that Yunus endorsed (10-15% above cost). However, we have been urging our Field Partners to raise their interest rates because we feel it’s critical to their growth and the growth of microfinance in China. Microfinance in China is in its nascent stages: over 600,000,000 people live without access to credit. Only a handful of MFIs exist to serve this market, and each remains in the ‘start up’ phase of organizational growth. They are barely financially sustainable and thus only able to serve a small number of borrowers. The low interest rates our Field Partners currently charge borrowers barely cover the high operating costs that come with servicing microloans in China. Our Field Partner in Inner Mongolia serves borrowers living over 100km away, and its staff travels this distance to collect repayments and provide training on a bi-weekly basis. It should also be noted that staff members at our Field Partners, while their dedication is unparalleled, are not much more economically well-off than the clients they serve and they lack professional training in fields key the microfinance industry.
These MFIs will never be able to scale or reach a higher level of impact on poverty unless they can hire highly qualified staff (especially in finance, IT, and management) and invest in their own infrastructure (data management and risk control systems, etc.) so that they can serve millions of clients rather than only hundreds. While new technology is constantly being innovated to make loans less costly to provide, our Field Partners need access to this technology themselves and professional staff that can implement its use in an effective way. These investments in organizational infrastructure are costly, but any institution (for-profit or nonprofit) must make them in order to reach a higher stage of development. In the case of MFIs, these investments will not only serve their financial bottom line, but they will also support the social bottom line—allowing them to increase the number of clients they serve and their impact on poverty exponentially.
As Muhammad Yunus indicated, the focus of microfinance should be on providing opportunities to the poor, not to profit from them. However, microfinance was always intended to be a sustainable and scalable way to help the poor—one that compensates a lender for the opportunity cost of lending out money enough that the lender can provide more microloans to more people. Thus, it is a mistake to think that 1) interest rates on microloans should be judged by a universal standard and 2) that interest rates above a certain threshold (e.g. 20%) indicate that a MFI has lost focus on its mission. MFIs have a responsibility to sustain and scale their operations. This will mean raising interest rates. But, it’s a certainty that the hundreds of millions of potential borrowers in China who would gain access to credit would think the higher cost is worth it.