NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

By NextBillion reader Lance Durham

-Borrowers don’t have much collateral.
-Little collateral means that they can only get small loans.
-Moneylenders make these small loans at very high interest rates.
-Very high interest rates mean that borrowers won’t make much profit.
-After the loan is repaid, borrowers do not have much more collateral than they did before (because they did not make much profit).
…and the cycle continues!-Little collateral means that they can only get small loans.
-Moneylenders make these small loans at very high interest rates.
-Very high interest rates mean that borrowers won’t make much profit.
-After the loan is repaid, borrowers do not have much more collateral than they did before (because they did not make much profit).

Now, what piece of that cycle can change?
–can the moneylender lend a larger sum?
–can the moneylender lend at a lower rate?
–can the borrower take a smaller loan?
–can the borrowers do something more profitable with the loan?

The answer to all of these is ’YES’…at least in theory. But, the moneylender lends based on the condition that he gets paid back more. And, since he is a monopolist, he sets the terms.

The moneylender will look at the borrower and decide how much to lend based upon the borrower’s resources and what the borrower plans to do with the loan. Since he is a monopolist, he can really decide how large a loan the borrower will take and how high the interest will be on it. He estimates how much the borrower will make and sets the interest so high that the borrower will make just enough to live off of and will be forced to return to the monopolist for another loan next time.

It would appear that his is the best strategy for the monopolist; it seems like guaranteeing that he makes the maximum return would make him very rich. But, oddly, this is just not so. The moneylender actually keeps himself poor with this strategy. How so?

The problem is that the borrowers never have more collateral and never accumulate more productive assets. As a result, they cannot borrow any more than they did before. Over time, what happens is that borrowers pay the moneylender 200% on a $50 loan instead of 10% on a $5,000 loan; the moneylender receives $100 instead of $500.

The end result is twofold:
1) High interest rates keep the moneylender poor along with everyone else. He services many small loans instead of some (later, many) big loans.
2) High interest rates keep the moneylender a ’monopolist’ and, thus, ’in power’.

For some readers, this may put a new spin on ’why we should not charge usurious interest rates’ or ’why microfinance helps’ or ’how microfinance will grow’…usury is a mindset of ’extraction’ and ’selfishness’, of taking everything you can get as fast as you can get it…reasonable interest rates are a mindset of ’investment’ and ’cooperation’, of investing in your borrowers/ their business so that the two of you (the lender and the borrower) will grow together. Cocreation, if you will.