Moving Beyond Microcredit – While Keeping Lending Costs In Check
Editor’s Note: Recently, Bryan Farris spoke with Mary Ellen Iskenderian, President and CEO of Women’s World Banking, one of thought influencers and industry leaders in microfinance with a focus on female entrepreneurs and customers in 27 countries. As WWB notes, the organization not only provides women access to financial services but “also control over their assets.” This post is the second of several topical discussions centered on the many financial, cultural and societal issues facing women in developing markets (earlier posts can be found here and here).
The microfinance sector has realized the need to move beyond microcredit, however new services are expensive to offer. And yet, critics often cite high interest rates when claiming that microcredit exploits the poor. In this discussion, Mary Ellen Iskenderian and I grapple with these issues and more. How can the MFI sector reduce costs and expand offerings? How will MFIs encourage the poor to save for the long run? Can subsidized programs, like match savings and financial education programs, have an impact on behavior?
NextBillion.net: There has been a lot of discussion lately about whether high interest rates in microfinance are ethical. I’m more concerned with whether they are effective. From the point of view of a CFO, any debt that a business takes on should be put to use in an activity that earns a return higher than the cost of debt. The cost of microfinance debt is extremely high, which makes it very challenging for small businesses to earn a sufficient return to actually climb out of debt using the loan. The business may be able to pay off the loan, but may not be retaining any earnings or accumulating capital.
There are several stories, like the one you described in your interview with Dowser, in which a woman takes out and repays several successive loans and is successful in growing a business. Clearly the loans have been beneficial to some, but it seems to me that the high cost of debt will make it challenging for most businesses to deploy that capital in a way offers a return sufficiently high enough that the financial instrument is accretive to capital.
How do you solve the problem of high interest rates? Should we be looking for a way to provide subsidies to high rates? Or, is it better to encourage transition to savings as a vehicle for asset accumulation?
Mary Ellen Iskenderian: I must say that I am a bit biased because I tend to break out in hives when I see the word ’subsidy’. I’m worried I might sound like an old microfinance hack when I say this, but I see a different path. The truth of the matter is that these small businesses have already evolved in an environment with high cost of debt.
Take a fruit seller in Colombia; the way she has financed her business for decades is by going to the loan shark in the morning, buying fruit, selling it and paying him outrageous rates to repay the money by the end of the day.
It’s important to remember that despite the seemingly high rates that MFIs have, small businesses can cover the spread.
Having said all of that, we are starting to see some very competitive microfinance markets. If you look at Bolivia, they’re down to single-digit interest rates. This happened because of two things:
- Great regulation
- A lot of competition
The other piece of the puzzle here is that the onus is on the MFIs themselves. If an MFI is making extraordinary profits, a high return on equity or a large return on assets, I do believe that at least some of that profitability needs to be passed back to the customer either through lower rates, reduced fees or another way. In fact, what causes MFIs to be so expensive is usually the hidden fees rather than the actual outright interest rate.
I don’t think a subsidy is the way to go about reducing rates because, in the end, the reason that microfinance has been so successful to-date is that it has always been about sustainability-sustainability of the institutions to recover their costs as well as sustainability of the borrower to make on-time payments.
NextBillion.net: The entire concept of match savings and conditional cash transfers goes against the for-profit, financially sustainable model which allows one to scale – how do you balance one versus the other?
Iskenderian: I don’t see them as mutually exclusive. I could certainly see a match savings program in the context of what would otherwise be a for-profit loan program.
Again, so much of this is about changing behavior. When we talk about financial education and the need for people to understand what these products mean, it is more important that the education changes their behavior than that they understand what compound interest means.
NextBillion.net: Great point. In terms of changing behavior, does ’match savings’ actually increase the amount that people save or is the impact seen by an increase in the number of savers?
Iskenderian: As you know, match savings hasn’t been widely applied in the field, but from what I do know about it, its certainly true that match savings does create that behavior change: people who would not otherwise save, do.
NextBillion.net: The flip side of that is interesting as well. What is a bigger issue, is it that people are choosing not to save and need to be encouraged to change their behavior? Or is it that savings and deposit taking is not an option that is widely available? Which is the bigger problem?
Iskenderian: A great question. What we see time and time again is that when a large mainstream bank takes small deposits and processes tiny withdrawals several times during the course of a month, it becomes prohibitively expensive for the bank. Finding institutions to do this more efficiently and more cost-effectively is absolutely the challenge of microfinance.
It is for this reason that mobile money has everybody so excited; it is one of the most tangible ways to get the costs down to a more manageable level.
In the Dominican Republic, we’re working with one of our partner organizations who has been a deposit taking bank since 2003. Their savings accounts are very small-with an average balance of about $30. The costs of managing such small accounts are incredible, but they are doing it because its so much a part of their mission. The critical nut to crack is how to decrease cost and increase convenience.
Ultimately, deposit taking needs to expand, which will happen gradually, but once it does a behavior shift is required.