CAGP defends higher micro finance rates

Washington-based group says rate productive.

The Washington-based Consultative Group to Assist the Poor (CGAP), a consortium of 33 development agencies that support micro-finance, has found nothing wrong in micro-finance institutions (MFIs) charging up to 40 per cent interest to poor borrowers.

Even the cost of credit for beneficiaries under the government's IRDP (Integrated Rural Development Programme) scheme is as high as 26-38 per cent, taking into account transaction costs including bribes.

A CGAP paper, released this month, says micro-finance lenders have to typically add a charge of about 20 percentage points to interest cost and also loan loss provisions to determine the interest cost for the micro borrower.

The 20 percentage points charge is on account of administrative costs due to small sizes of loans and a large number of borrowers being spread across a much wider region.

The conclusions of the paper are significant in the backdrop of authorities in some districts of Andhra Pradesh ordering closure of offices of some MFIs for charging "exorbitant interest rates" on small loans.

The CGAP paper also points out money raised from the MFIs are deployed in activities like selling vegetables and rearing cattle that generate between 117 per cent and 847 per cent rate of return per annum.

The borrowers are constrained from pursuing them purely because an adequate amount of finance is not made available to them. Loans made available to them even at interest rates as high as 35-40 per cent per annum add a significant amount of value to the household income.

Making a hypothetical comparison, it says a big lender lends $10,00,000 to a single borrower while a micro lender makes 10,000 loans of $100 each to build the same size of loan book.

Assuming the big lender's loan is repaid quarterly, it has to process four payment transactions per year. A micro-lender's borrowers probably make repayments monthly or even more frequently, generating at least 1.2 lakh transactions per year. While big lender's administrative cost is $30,000 per year, that of a micro-lender is at least $2,00,000.

Covering this administrative cost requires a 20 per cent charge on loaned amounts, resulting in an interest rate of at least 33 per cent (10 per cent cost of funds + 1 per cent loan loss provision + 20 per cent administrative costs). The administrative costs may be much higher in young MFIs that are too small to take advantage of economies of scale.

The administrative costs involve identifying and screening clients, processing loan applications, disbursing loans, collecting repayments, and following up on non-repayment.

The loan recovery rate on IRDP loans vary between 10 and 55 per cent. In contrast, leading MFIs in India enjoy nearly 100 per cent repayment rates.

Also in IRDP scheme, there is widespread credit diversion and low levels of awareness of repayment conditions.

According to the agency, attempts by governments to regulate this industry by capping the rate of interest in various countries have resulted in denial of access and withdrawal of players from offering these products and services thus forcing these very poor people to return to money lenders.

There is no evidence of it actually having reduced the effective cost of financing for small borrowers.

The best way for governments and donors to lower interest rates without making microcredit unsustainable is to promote competition and innovation, both of which improve efficiency and lower prices, it says.