Making Sense of Microcredit Interest Rates

September, 2002     Ruth P. Goodwin-Groen

Why do microfinance institutions (MFIs) charge such high interest rates to the poor? This brief highlights some of the key issues related to microcredit interest rates and the role of donors.

Microcredit interest rates are set with the aim of providing viable, long-term financial services on a large scale. MFIs must set interest rates that cover all administrative costs, plus the cost of capital (including inflation), loan losses and a provision for increasing equity. Unless MFIs do so, they may only operate for a limited time; reach a limited number of clients; and will tend to be driven by donor or government goals, not client needs. Only sustainable MFIs can provide permanent access to financial services to the hundreds of millions who need them.

Although microcredit interest rates can be legitimately high, inefficient operations can make them higher than necessary. As the microcredit market matures in a given country or region, donors and others should pay more attention to reducing operating costs to ensure the most efficient, competitive interest rates possible.