Interest Rates: Tenets of Micro-credit for Poverty Reduction

During the early phases of the ‘micro-credit movement’, one of the arguments for establishing special micro-credit delivery institutions aimed at addressing the needs of the poorest of the poor, was the issue of interest rates. It was argued that market interest rates were too high for the rural poor, especially the poor micro-entrepreneurs, female petty traders and vendors, to afford.

Thus it was considered one of the issues hindering satisfactory access and increased outreach to the poor clients. These recognitions and the continued interest to fight poverty effectively resulted in applying subsidies, or slightly lower interest rates than those on the market, which would make micro-credit affordable but not entirely free. Since then new evidence shows that subsidised interest rates are actually detrimental to the competitiveness and growth of the poor clients and would make them further dependant on ‘free hand-outs’. The resulting outcome from these two consecutive evolutions has been that most MFIs charge market interest rates. In addition, further administrative and risk premiums are also charged which result in MFI loans being more expensive than commercial loans. While some commercial banks charged an interest rate of between 44% to 46% (data collected during May 2001) per annum in Malawi, MFIs were charging as much as 68%

to 74% per annum (also data collected during the same period). Nevertheless, the poorest of the poor may not be able to access the commercial loans because of the non-flexible lending criteria of these big banks. Furthermore, because commercial banks are not prepared logistically to service the needs of the poor clients for very small amounts, MFI operations flourish based on comparatively expensive loans and taking advantage of the incompatibility of the commercial bank services to the needs of the small borrowers. Consequently, micro-credit programmes charging higher total interest rates actually may be contributing to the poverty status of the borrower.

The higher interest rates put an extra burden on the poor clients when repaying. Especially, because the predicament is that while the client’s income may fluctuate depending on business, market and other external environment related factors, she has to make the repayment at a fixed time or loose whatever collateral she has put up. Thus, in order to make repayments, the borrower may dig deeper into her savings, profits, or other income sources, such as from the husband or children’s work, resulting in increase in poverty at the household level. The issue of the high interest rates reflect the financial self-sustainability paradigm as explained by Mayoux (2000) and reconfirms the increased burden put on women for repayment of loans. Within the empowerment analysis, the high interest rates and resulting high repayment rates puts more stress on the women to conform to existing gender roles and relations because as noted in some cases in Malawi and Ethiopia, in order to meet the weekly repayments the woman had to depend on the husband’s income.

Furthermore, the high interest rates also had a negative impact on the poverty reduction capacity of the micro-loan since it did not result in sufficient income levels.

ECONOMIC RESEARCH PAPERS NO 74 (January 2003)

Factors Impeding the Poverty Reduction Capacity of Micro-credit: Some Field Observations from Malawi and Ethiopia by Sunita Pitamber To learn more about this author, visit African Development Bank's Website.

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