The price of micro-finance —Syed Mohammad Ali

The high intermediation costs for a typical microfinance provider seem justifiable. Microfinance providers can however use other existing infrastructures or technologies to significantly lessen these operational costs

Since the creation of the Grameen Bank in Bangladesh, the use of micro-finance to alleviate poverty has gained recognition and support around the developing world, including South Asia. Besides providing credit, institutions have been developed to provide a range of other services for the poor, such as savings, home loans and even insurance.

However, the fact that micro-finance institutions end up charging much higher interest rates than commercial banks has led to much criticism concerning their alleged rent-seeking tendencies. To be fair, however, the role and compulsions of micro-finance merit a closer look, including their need to charge high interest rates, before concurring with such an unflattering conclusion.

Before focusing specifically on the issue of interest rates, however, let us contextualise the micro-finance industry in Pakistan. The financial sector in Pakistan as a whole has overall grown steadily in the recent past. Yet the sector’s outreach has largely been focused on a niche market in mostly urban areas, where it caters to the medium-high income group and the corporate sector. There has been lesser emphasis on increasing access of financial services to poorer people since reaching out to them is conventionally considered risky and not very cost-effective. Several micro-finance institutions have however now begun to specifically target the abundance of economically active poor people within the country.

The premise for this ongoing effort is that poorer people do already avail financial services, but from informal sources, including middlemen, feudals, shopkeepers or the committee system of pooling money by making monthly contributions among an informal group.

The terms and conditions of the more professional of these informal credit suppliers can be quite stringent. For example, moneylenders can charge interest rates of over 100 percent. The worst form of exploitation occurs when borrowers are subjected to the generational cycle of bonded labour due to debts owed to powerful landlord.

Yet, microfinance cannot always target the poorest people who fall prey to these most exploitative forms of informal lending. This is because microfinance lenders require their clients to form groups to qualify for lending, whereby peer pressure can be exerted to ensure repayment instead of conventional forms of collateral.

Moreover, people need to demonstrate their ability to use the provided loan to a productive purpose whereby guaranteeing return of the loan, as well as the interest being charged on it. Poorer people often have problems on both fronts. Moreover, micro-finance field officers often end up offering loans to those who have the demonstrated ability to return their money, even if they do not necessarily use the credit provided to them for productive purposes.

The extent to which lowering interest rates could make these loans more affordable for poorer people that are readily willing to use them for productive purposes would be an interesting question to examine in more detail. But the proponents of microfinance have instead begun to argue that this debate about affordability of their loans is not really meaningful.

In the case of Pakistan, microfinance institutions argue their clients make profits ranging between 150 percent for a grocery store in the rural areas to 100 percent for a service industry like barbers, shoe cleaner etc. Paying interest rates of 30 percent or more is thus not considered a problem.

Instead, the biggest challenge for micro-finance is said to be increasing access of its financial services, not the affordability of these services. Charging high interest rates is one evident way to enable microfinance providers to not only sustain but also to extend their outreach beyond the million and a half clients which are being presently served by the microfinance sector in Pakistan.

A conclusion concerning this issue of interest rates would still be hasty without discussing the reasons why delivery costs in microfinance are relatively higher than those charged to commercial bank clients. Compared with commercial or corporate banks, where cost of borrowing is the main component, in the microfinance industry it is the cost of operations that are really high. Instead of having corporate clients with huge lending portfolios, the business model for both credit and deposit products for microfinance requires providing these services at the client’s doorstep. Thus, a microfinance institution justifiably wants its cost and pricing rates to be compared with peer micro-lending entities, instead of commercial banks.

The Pakistan Microfinance Network has in turn reviewed this pricing issue through an international comparative study. This analysis indicates that interest rates for microfinance in other developing countries are upward of 30 percent, except in South Asia. South Asian interest rates are seen largely to be skewed by two countries — India and Bangladesh — both of whom have outreach of millions of clients each, which has enabled them to achieve economies of scale in terms of their cost structures.

In view of the above arguments, the high intermediation costs for a typical microfinance provider seem justifiable. Microfinance providers can however use other existing infrastructures or technologies to significantly lessen these operational costs. For instance, mobile phones can be used to facilitate financial transactions. Some microfinance institutions have begun linking up with the postal service to lessen their costs. However, the money being saved by these institutions need not necessarily be used to expand their operations, but can also be used to lessen interest rates.

Several entities are actively trying to facilitate and support micro-finance in the country. It would be worthwhile for them to assess the extent to which lowering interest rates may enable microfinance providers to reach out to more poor people within the same communities, instead of spreading their outreach to relatively better off segments of poor localities in other areas.

The writer is a researcher. He can be contacted at

Reproduced by permission of DT.\06\02\story_2-6-2009_pg3_3


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