Microfinance: Don’t charge to enlarge

A STORY in the finance section this week looks at what has happened to microfinance interest rates. To summarise briefly: we argue that as microfinance for the very poorest borrowers has expanded, microfinance institutions (MFIs) have had to raise their rates. As MFIs target poorer, less reliable customers, they need to charge higher rates to cover increased defaults and steeper funding costs. So our story looks at the effect of increased access on interest rates. But what about vice versa? What effect do changes in interest rates have on microfinance access? That is another perennial source of controversy in the microfinance community. Some argue that demand for microfinance loans is elastic: borrowers respond strongly to changes in the interest rate. With higher interest rates, far fewer borrowers are willing to take out a loan. That means to increase access to microfinance, lowering interest rates is preferable.Others disagree: they argue that demand for loans is rather inelastic. Higher interest rates do not deter borrowers, possibly because the alternatives—such as moneylenders—are so much worse. Contrary to what the elastics say, you need to increase interest rates if you want to increase microfinance access. Doing so will attract shedloads of capital as funders are tempted by the possibility of higher returns. That will increase the total pool of funds to …

Link to article: www.economist.com/blogs/freeexchange/2014/02/microfinance-0?fsrc=rss

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