Posted: September 01, 2009
Guest column:42 percent interest rates…are you crazy?
How microfinance works in the developing worldBy Mike Wiesner
Every morning Maria gets up at the crack of dawn to the sound of babies crying and roosters crowing. It’s another blistering day in her small village of Santa Rosa, Honduras, one of the poorest areas in Central America.
Maria is a single mother of five, abandoned by her husband. Each day is a struggle for survival. It would be easy to give up, but Maria is a fighter, dedicated to improving her life and the lives of her children with microloans to start her own business. She has seen in her village the global effects of the recession, and her neighbors have less money to spend. Her tortilla business has done fairly well, but the price of corn and flour has increased substantially so she would like to diversify her business with her next loan and start selling firewood, which she has seen a need for within her village.
And today is a special day because today, Maria will pay off her second loan of $131. This will be the last of 12 payments of $13.21 over six months totaling $158.51. And if you asked Maria, she would not complain about the $27.51 she paid in interest, but would say, “Before (receiving a microloan) I didn’t have any hope of having my own job. Now I have my own business and my life has gotten better.”
An interest rate of 42 percent on a loan in the United States would be considered either very lucrative or very usurious, depending on your viewpoint. Yet in developing countries, 30 percent to 45 percent is the average annual percentage rate paid on loans made to women through microfinance institutions (MFIs).
“Why so high?” is the No. 1 question asked by Americans when they first hear about microfinance. The misunderstanding is that 42 percent interest in an American context of car loans, credit cards and house loans does not reflect the requirements of servicing small loans in developing countries.
Providing financial services to the poor is expensive, especially in relation to the size of the transactions involved. This is a key reason why traditional banks do not make small loans. For example, a $10,000 car loan requires the same resources as a $100 microloan, a significant difference in the per unit transaction cost.
Regardless of the amount, microfinance loan officers must visit a client’s home or place of work, evaluate creditworthiness based on interviews, and in many cases, follow through with visits to reinforce the discipline required for repayment. In the case of Maria, it cost $27.51 to give her a microloan.
While that does not seem unreasonable in American terms, in many cases it might represent 25 percent of the loan. Often, this is misunderstood by potential donors or grantors and leaves microfinance with a reputation of charging too high an interest rate even though it directly covers the loan administration.
The microfinance idea is as basic as the old biblical proverb about “teaching a man to fish.” It empowers very poor people to use small loans and other financial services to pull themselves out of poverty. Most programs focus on women because women are more likely to use their profits to invest in improving the quality of life for their families.
Women also understand reinvesting in their businesses to make them grow and have established themselves as better credit risks. Ultimately, the extreme poor are creditworthy individuals. All they need is an opportunity and they will take it. They are desperate to take it.
Most MFIs are serving the front line in the war on poverty and have seen the effects of the global economy even at the lowest economic level. Despite the current economic conditions, microfinancing pioneer Muhammed Yunus, who won the 2006 Nobel Peace Prize, believes it is possible to eradicate global poverty within two generations.
He maintains that with microfinance leading the charge, the United Nations’ Millennium Development Goal of halving poverty by 2015 will be met and exceeded. Furthermore, Yunus’ ultimate goal is to eradicate poverty completely, and he predicts that future generations, like those of Maria, will only be able to find poverty in a museum.
Mike Wiesner is International Director of Development for Adelante Foundation, which operates a microfinance institution in Honduras. Adelante’s U.S. office is based in Englewood. E-mail Mike at email@example.com.