The worldwide median for microfinance borrower interest rates was 30.9% in 2005.  Holy cow!  That’s a lot more than you and I would pay if we went down to our local bank and took out a loan (unless “your local bank” is code for your maxed-out credit card).  So what is going on here?  

Microfinance has sometimes been critiqued for charging high interest rates to really poor people.  One counter-argument is, “well, look at the only other options poor folks have – informal money lenders who can charge up to 100% per month.  At least it’s better than that!” 

I say, “not good enough!”  People should have access to the most competitive rate possible, regardless of their wealth.   So the question then is, “are microfinance institutions charging their customers the best rates possible?”

The answer is a highly unsatisfying “it depends” and “it’s getting there.”  Darn that complexity!  But I can’t make a blanket statement and speak for every single microfinance institution out there as, just with every other business sector out there, there are a range of players with a range of solutions, all clamoring for your love.

But let’s break down the fee structure across the entire value chain for you so you can see precisely who is getting paid what and where the money is going and where the variability comes in.  We’ll start with the borrower, move on to the microfinance institution, the microfinance security issuer, MicroPlace, and end up with you, the investor.  One entire value chain, coming on up:

The Borrower:  The chart below is some old data, but still pretty useful.  It shows some rates that banks, microfinance institutions, and moneylenders charge borrowers in some countries.

First off, we need to get rid of moneylenders!  Holy cow!  Bring banking services to the poor now!

The Microfinance Institution:  So why are the microfinance institutions charging more than the banks?   To understand this, let’s  compare the costs of two hypothetical lenders: BigLender and MicroLender.  BigLender makes a single $1000 loan, while MicroLender makes 100 loans of US $10 each.  They are both lending out the same amount of cash, $1000 and, if they are both going out to the commercial markets to raise money, they both pay the same market rate for the cash.

Their administrative costs, however are not the same.  Making a single $1000 loan might cost BigLender $3 (or 3% of the loan amount) in staff time and other expenses involved in appraising, disbursing, monitoring, and collecting the loan.

MicroLender’s administrative costs, however, will be much higher than $3 because MicroLender has 100 borrowers to chase around and follow up with instead of just one.  Furthermore, many of MicroLender’s clients may be illiterate, don’t have access to the internet, and live in really remote places without telephones. Lending to, and collecting from, such clients requires a heck of a lot of bicycle riding out to villages and personal interaction.  Also, MicroLender’s borrowers probably make repayments monthly or even weekly generating thousands of transactions per year.  Covering this cost requires more money, maybe $20, resulting in a higher interest rate.

A couple of other factors impact the rate that MicroLender charges its clients.  These are:

*  Social justice orientation of MicroLender:  Some microfinance shops specifically target the hardest to reach, most needy borrowers.  Other microfinance shops also offer basic health services or training on how to run a micro-enterprise and how to account for the money as many of their borrowers don’t have MBAs or CPAs.  Services like these cost money.

*  Capital source for MicroLender:  Some microfinance shops get their money on the capital markets.  Others are funded by soft money:  charities or government aid programs.  This would lower their costs.

*  Efficiency of the MicroLender:  Things like size, scale, length of time the organization has been in existence, and on the ball-ness also impact rates.  Right now, we don’t have a really good view into this, but hold onto your seats!  Some really smart people are working at getting more transparancy here. Interestingly, CGAP, a sort of microfinance advocacy / think tank group, reported that microfinance rates have been dropping fairly fast.  From 2003 to 2006 global rates dropped 2.3 percentage points per year.  In sub-Saharan Africa, interest rates dropped at a rate of 1.4 percentage points from 2003 to 2006.  It’s that whole power of the markets thing at play here with increasing competition and better institutional efficiency driving better service for the poor.  Lesson to learn here: engage the poor in business instead of refuse to do business with them because they are poor.  The poor benefit when businesses take them seriously.

Microfinance Security Issuer:  The Microfinance security issuer then packages up the loan, securitizes it, and clears it through the gauntlet of Wall Street lawyers and regulators.  And if you want to know more about these guys, see the default rate of microfinance security issuer section of this post.  They charge about 3% for their services.

MicroPlace:  MicroPlace runs a lean machine here and, one day, the our only revenue source will be the 1% fee that we charge the microfinance security issuers on our site.  We are actually owned by eBay who saw the power of what we are trying to do and invested in us to cover our costs until we get to scale.  The 1% goes to cover the costs of this fabulous website, along with our services of maintaining brokerage compliance and offering customer service to people like you.

Microlender:  The investor – and that’s you! – gets anywhere from 1% to 3% interest for the use of your capital to help a poor person work her way out of poverty.

So, that’s it!  The entire value chain. MicroPlace is a marketplace where we offer you, the investor, many different options and let you vote with your dollars as to what you think the best interest rate is.  We want to unleash the power of the markets.  If you, as an investor, feel that an interest rate a borrower is paying is unacceptable, well, you get to vote with your dollars.  Just click on right by the investment and find one you like better.  If you feel the borrower interest rate a firm is charging is great, vote with your dollars again!  Click and invest!  So now you are armed with knowledge.  I hope you’re not dangerous.