Tracking loan costs for microcredit

from the Vancouver Sun

Don Cayo is a columnist in Vancouver who writes on poverty related issues. Here is a excerpt on the interest charges on micro credit loans. This is related to the story about Muhammad Yunus saying there is no place for profits in microcredit - Kale

by Don Cayo

Annual interest of 25, 50 or maybe 100-plus per cent: What's fair? Where, exactly, should the line be drawn between loan-sharks and worthy micro-credit programs? Between enterprises that exploit poor people who can't get conventional loans and those that help them?

There's no short answer.

Rates that sound to Westerners like gouging -- 25, 35 or even 45 per cent a year -- may, in fact, be the least a responsible lender can charge and stay afloat. Factor in the inflation that plagues many developing economies, plus the high cost (at least, high as a percentage of principle) of administering tiny loans, and you can see how what sounds like usury can be the bare-bones minimum.

But 100-plus per cent in an economy where inflation is reasonably under control? To most of us, that's over the line.

It gets trickier, of course, when the number is in between -- too high to be readily justified but too low to be clearly out of line, especially if the stated interest rate is in addition to confusing fees and caveats. The on-the-ground reality is so complex that even micro-finance professionals -- not to mention unlettered peasants -- find it hard to compare the costs of competing agencies.

The issue has been around for years, but it came to a head after Mexico's Banco Compartamos, which started life as a non-profit, became a profit-seeking enterprise. It went public early last year on the Mexican stock exchange, attracting money from Wall Street, among other places.

So far, the investments are paying handsomely, perhaps no surprise given that its loans can cost more than 100 per cent a year.

To defenders of the free market, outside investors provide much-needed capital. And only market mechanisms, which reflect the basic law of supply and demand, can establish a truly fair price for loans -- the point where lenders' willingness to put up the money converges with borrowers' willingness to pay.

Competition in the field may, indeed, work as it's supposed to in a country like Bangladesh, the home of Muhammad Yunus's famed Grameen Bank and of several other large, sophisticated micro-credit agencies. There, lending concepts have come to be understood by even the poorest clients, and many agencies compete with interest rates of about 25 per cent.

But, as Yunus underlined in a telephone news conference from a micro-finance summit in Bali on Monday, micro-credit was originally developed for people who were ill-served, or unserved, by the establishment market.

In many of the 100 or so countries where micro-credit is a key tool to combat mass poverty, that's still the case. Untold millions have no access to loans from a reputable agency. In such places, a new market-based player has no competition other than unabashed loan sharks -- local money-men who, typically, lend out five currency units at sunrise and collect six in repayment at sundown.

There's also a great danger of unfairness in what economists call "asymmetry of information." Well-heeled lending institutions can calculate costs and profits to the penny; unschooled borrowers often have no idea of what they're getting into or what a fair-priced alternative would be.

So I applaud Yunus and his colleagues from 44 other micro-finance stakeholders -- mostly those who fund micro-credit agencies, rather than those who actually make loans -- for an initiative launched Monday to expose lenders' actual prices to the light of day. A new NGO, MicroFinance Transparency, will collect and publish data on the cost of loans from lenders all over the developing world.

Link to full article. May expire in future.