Why Charge Any Interest At All?

1 March 2010 at 03:23 15 comments

By Peter Marchant, KF10 Azerbaijan

Microfinance interest rate discussions usually center on how much and often overlook the question of whether poor microborrowers should pay any interest at all. Kiva lenders are a philanthropic bunch. They could eliminate interest rates and cover administrative costs with donations, but for economic and ethical reasons they shouldn’t.

The Economics:

  • Sustainability: The point of microfinance is sustainable development through broader access to capital. Donation capital is fickle, fluctuating and, ultimately, finite.
  • Borrowers Can Pay: Borrowers by definition have economic opportunities. Their businesses often operate in inefficient markets where access to capital to purchase a motorcycle, rent shop space or buy wholesale can lead to returns that easily cover interest expenses.
  • Limited Donation Capital: Kiva lenders have generously funded more than $120 million in loans over 4 years. The current global microloan portfolio is nearly $40 billion. Interest rates allow microfinance to reach more people.
  • Unintended Consequences: “Free” loans undermine local MFIs charging market interest rates, squelching sustainable local money markets. Direct food aid has often undercut local agriculture leaving recipients even more aid dependent.
  • Efficient Use: People care better for things they pay for. Charging for the use of money incentivizes borrowers to put capital where it creates the most value.
  • Interest Returns to the Economy: MFIs don’t spend interest income on private jets, lavish offices and spa treatments. Wages usually represent the largest component of an MFIs administrative expenses. MFI employees live in the communities they serve and recycle their wages into the local economy.

The Ethics:

  • Microfinance Not for the Very Poor: The poorest of the poor, suffering disease, conflict, natural disaster or disability cannot benefit from microfinance because they lack economic opportunity. They require direct aid that puts food in their bellies, but they are not asked to pay interest and they have no use for an interest free loan. Microfinance and direct aid are different development tools that should target different development needs.
  • Limited Donation Capital: Every dollar spent providing free capital to a microfinance borrower who can afford to pay for it, is a dollar not spent on someone who might not live to tomorrow without it.
  • Relationships: Providing free loans fundamentally changes the relationship between borrower and lender from one of partnership based on mutual interest in shared success to one of wealthy donor and powerless poor person.
  • Independence: Interest rates mean financial independence for borrowers. Subsidized loans foster dependence on hand outs.

So even if it sometimes feels wrong to charge interest to microborrowers, it is important to remember that lenders, borrowers, and sustainable development all benefit from competitive interest rates.

Peter Marchant is a Kiva Fellow serving his first placement with AqroInvest in Azerbaijan. Click on Azerbaijan Borrowers for a list of Azeri borrowers currently on Kiva or click Supporters of Azerbaijan to join the Azerbaijan lending group.

Entry filed under: KF10 (Kiva Fellows 10th Class). Tags: , , , , , , , , , , , .

The Dangers of Being an MFI Loan Officer The Forest Through the Trees

15 Comments

  • [...] Interest encourages borrowers to be disciplined for numerous reasons: (1) borrowers are more inclined to only take out the amount of money they actually need; (2) they pay back sooner to avoid paying more interest; (3) by charging interest, you weed out the clients who just want the money because it is available and free (also see Peter Marchant´s post) [...]

  • [...] rate in a town loaded with microfinance banks. For a fuller treatment, see recent blog posts by Peter, Eva, and Meg. Possibly related posts: (automatically generated)Is a Kiva loan really interest [...]

  • 3. Jan & John, KivaFriends  |  3 March 2010 at 09:15

    I understand why MFI’s need to charge interest and totally agree that people take pride in what they pay for. However, I am pleased as a Kiva lender to be able to lend without interest. This feeling will only hold as long as I can trust Kiva to continue to search out MFI’s with strong social missions, aiming to reach as far out to the ‘poorest’ as they are able, then I can do my part by lowering their costs in that initiative. jan

    • 4. Peter  |  3 March 2010 at 23:49

      Jan,
      It is great that Kiva can provide interest free financing to support socially focused MFIs. However, there is a cost to Kiva’s capital in terms of time and money spent gathering borrower information and posting it to the internet. It is certainly lower than other financing options, but it is greater than zero. There is also a return to the Kiva lenders. The return is social rather than monetary and comes in the form of learning about the specific borrower who is repaying your loan and their business. These costs and returns are both part of what makes Kiva work and indeed helps MFIs lower their cost of capital and reach out to more and poorer borrowers.

  • 5. david oglaza  |  3 March 2010 at 08:00

    I agree that interest rates need to be paid. The MFIs are trying to create sustainable businesses in order to reach as many people as possible. If waiting for donations only then limited impact.

    People can lend to only those with limited interest rates via choosing via KIVA only those that have low interest rates.

    That way if people dont fund those with interest rates then they either reduce them or die!!

  • 6. Fehmeen  |  2 March 2010 at 11:29

    I think the major reason we object to interest rates is
    - they’re extremely high (often 30 to 70% higher than market rates, according to ADB)
    - they keep pushing a defaulter deeper into poverty upon repayment.

    In this regard, Islamic FInance is probably a better solution. Upon non-payment at the stipulated time, a fixed penalty is charged. This doesn’t accumulate with time (so there’s no sinking deeper into indebtedness) but acts as an incentive for prompt payments

  • 7. Alhassan  |  2 March 2010 at 10:47

    well said. i always look at aid as a waist of resources some times. the poor ,when economically resourced can do better. i have had severals experinces about aid and how it has ” ruined” the livelihood of the poor and the vulnerable in the society both near and far. in short aid makes the poor become lazy and can not think economically.
    interest rates are there to bring about the effective use of resources. great work and well done.

    • 8. Paul  |  2 February 2011 at 13:34

      History has proven that interest based money lending leads to a concentration of wealth, the reason for a number of social issues, retards real economic growth, deepens poverty and is considered a sin according to the main three monotheistic religions.

      What the poor of the world need, by poor I mean the 99% of the population that do not control the money mechanisms. We do not require aid, simply a just and fair money and banking system that allows mankind to grow and does not become a constraint to growth, education, obtaining healthcare and liberating REAL market opportunities.

      Creating real wealth on this planet will not be possible until the ability to create real money are returned to the people and not the priviledge of the interest based central banking money monopolies.

  • 9. RAJESH  |  2 March 2010 at 04:53

    I WANT TO KNOW ABOUT INTEREST CHARGE

  • 10. Jacob  |  1 March 2010 at 23:36

    Well said.

  • 11. marydear  |  1 March 2010 at 18:51

    Hey Peter, great post!

    I think many people outside of the sector don’t really fully process this sentence (ok well I didn’t) I just kind of lumped it all together.It is so important to keep the 2 separate – and remind people that overall, MFI’s do not target the porrest of the ppor!

    “Microfinance and direct aid are different development tools that should target different development needs.”

    thanks!

  • 12. June Miller  |  1 March 2010 at 14:01

    Thank you for this post. I have been one of those who didn’t like the idea of interest rates, but this really clarified the issue for me. I now see and appreciate the point of the argument, especially since I have always felt the lowering of dignity & self-confidence which can accompany the “rich” dealing out largesse to the poor (that’s why I was so keen on Kiva when I came across it) is so inferior to the feeling of achievement & dignity when working for oneself. And it makes it a business arrangement. Charity is all very well in emergency situations, but not ideal in normal times. Thanks again for a lucid and comprehensive response.

  • 13. karl baumgarten  |  1 March 2010 at 13:48

    Great post, spelled out my thoughts exactly.

  • 14. bgoldfinger  |  1 March 2010 at 07:43

    Way to spell it out, plain and simple.

  • [...] Marchant, Kiva Fellow: For economic and ethical reasons microborrowers should pay interests; http://j.mp/bua3Sr [...]


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