The concept of microfinance—providing loans and financial services to underserved populations—is designed for positive social impact. Microloans are offered with the goal of providing enough money to make a difference to an individual’s life, while still being manageable to pay back. While the sum may be small, the impact can be big, allowing people to start or grow businesses, expand farms, or pursue higher education. Often, the outcomes of the loan can provide a sustainable way for borrowers to grow their income. The first question that many people have when hearing about the concept of microlending to vulnerable communities is: what are the interest rates?
The application of microfinance has a price, which is usually covered by interest rates or fees charged to the borrower.
Understandably, this raises concerns that borrowers can be taken advantage of by lenders. At Kiva, we understand the importance of careful upfront due diligence, ongoing monitoring, and client protection. Kiva chooses to partner only with microfinance organizations that have a strong commitment to serving the needs of poor, vulnerable and/or excluded populations. In this article we will cover some of the common questions raised about microfinance interest rates.
Why are microfinance interest rates so high?
It may sound strange, but lending money costs money. Microfinance institutions (MFIs) must cover their operating costs in order to be sustainable and ensure they can continue to operate, and reach more borrowers. Each loan requires time, labor, and administrative attention—and it’s much more expensive to disburse 1,000 loans of $100 than a single loan of $100,000. Many MFIs work with clients in rural areas and must account for weekly or bi-weekly visits that can require travel across regions. These visits often combine education, healthcare and other financial services, adding to the human cost of each microloan. The expenses associated with operating an MFI is one of the reasons that microfinance interest rates often appear high in comparison to other loans. It can be misleading to compare the interest rates on other loans to those on microloans. Inflation also needs to be considered. In countries with high inflation rates, MFIs must factor that into their loans—for instance, an interest rate of 18 percent may seem high to some, but if inflation rises to 20 percent, the interest won’t cover the cost of the loan. In areas of high conflict, rates tend to be even higher due to economic and political instability, and MFIs in these areas must put aside a larger portion of their available capital as a provision against loan losses, a necessary means of ensuring that they have sufficient funds to continue to operate when faced with defaults. While average interest rates vary from country to country, a common way to monitor whether they are appropriate for their location is to look at cost to income ratios, which have come down significantly. As productivity increases, lending rates are falling, especially in more mature, competitive markets.
Do microfinance institutions profit from high interest rates?
Interest collected on microloans disbursed by MFIs allows these organizations to grow and reach more communities. Due to the high cost of reaching borrowers, however, profits on microloans tend to be low—if there are any at all. Kiva lists all of its Lending Partners’ return on assets (ROA), which shows lenders how much money the MFI is making based on the loans it provides against its operating costs. As you can see in the graph below, the cost structure includes little room for profit margins.
How can microfinance borrowers be protected from predatory lending and over-indebtedness?
Rigorous analysis and vetting are required to ensure that microfinance institutions are following responsible and fair lending practices. At Kiva, all of the microfinance institutions we partner with are subjected to a vetting process before becoming a partner, and during our partnership. As well as looking at financials, we perform a character assessment which includes references. This allows us to detect signs that could lead to predatory lending including "overaggressive" business strategies with a singular focus on growth over long-term sustainability, focus on consumer loans over productive loans, and the reputation of the partner in the market. Kiva only partners with MFIs with a social mission to bring financial services to the unbanked and economically underserved.
FAUSTA'S LOAN OF $300 THROUGH KIVA ALLOWED HER TO GROW HER BICYCLE BUSINESS AND SUPPORT HER FAMILY.
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All Kiva Lending Partners undergo a responsible pricing review that calculates their loan products' annual percentage rate (APR). That interest rate pricing is then compared to several factors in the profile of each MFI, including:
audited financial statements
return on assets (ROA)
inflation
operating expenses
current economic context of its country
typical client population
Through this process, Kiva identifies loan products with unusually high interest rates. For products with high rates, Kiva will seek and analyze additional information, such as:
executive compensation
dividend policies
pricing for loans offered by other MFIs operating in the same area
loan repayment schedules
As Kiva invests more in its partners, additional fair pricing measures are conducted that require customer impact evidence and self audits based on Smart Campaign’s Client Protection Principles, a set of widely accepted microfinance best practices. If justification for their pricing doesn't meet these standards, Kiva will end the partner relationship. Kiva also relies on feedback from borrowers themselves to assist partners in improving their practices. Impact evaluations and surveys conducted through Lending Partners or external providers help ensure that clients benefit from loans even if the interest rates may appear high. For example, one partner in Uganda has an APR of 84 percent—yet an independent impact study found that only 6 percent of its customers considered the cost of the loan too expensive. Those surveyed were asked if they understood and agreed with the terms and conditions of the loan; 92 percent reported that they did. Most importantly, 98 percent of survey participants reported that their income has increased because of the loan secured through this MFI.
Does Kiva charge interest?
Kiva never collects interest on loans and lenders do not receive interest from the loans they fund. Loans disbursed through Kiva U.S. are offered at 0% interest and have no fees. However, most Kiva Lending Partners do apply interest rates to their loans to cover the high operational costs of microfinance. Interest rates are what help enable microfinance institutions to bring loans to borrowers as well as offer services such as savings accounts, financial literacy training, and other support programs. You can find more information about the interest rates charged by a Kiva partner on their Lending Partner page as well as on the profiles of each individual loan.
