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The issue is not just whether these microlenders have "earned the rates of return required by commercial lenders in poor countries" -- many microlenders earned very high rates of return. The problem is that microfinance lenders can earn such rates only because they invest heavily in monitoring their loans (conventional banks don't have to monitor as intensively because their loans tend to be collateralized, and therefore the borrower retains an incentive to repay, even if the lender isn't poking about to check up on him weekly, as often occurs with microfinance).

The problem is that it is not easy to sell non-collateralized loan bundles (i.e. it is difficult for microfinance providers to leverage up, because outside lenders will be afraid that the microloans can very quickly lose value once they are in someone else's hands, in a way that is less likely to happen if those loans had been collateralized (which rely on third party enforcement and therefore can be collected more easily).
This is why private capital has remained very reluctant to invest heavily in microfinance, even in the face of apparently quite high rates of return (except where donors and other third parties explicitly or implicitly have guaranteed such investments).
None of this is to say that private investors will always stay out, just that it's really a lot harder problem to solve than to just ask the microfinance lender to raise rates or lower costs to improve profitability.


Perhaps in the future you could look into the new $5 Million Prize offered by Mo Ibrahim for African leaders who exemplify good governance. I would very much like to know your economic analysis of the incentives of such a prize


michael webster

Could someone explain to me how:

a) the micro loans have high interest rates, but
b) the loans are compatible with the Islamic prohibition on usury?

david stoker

The interest rates may seem high by our standards but some of these women were previously paying upwards of 300% interest a year. The loan sharks or suppliers keep them in a kind of bondage. For example, you could have a woman who buys supplies from a man at a price he sets and on condition that she sells any products she makes to him, and so, without other options and even if the profit at the end of a day is only 50 cents, she still enters into the business transaction. But such a system keeps the borrower in perpetual bondage to the supplier.

Another reason the rates are high is the high cost of operations. Microlending takes the banking to the people, literally-- a loan officer traveling from village to village on a dirt bike to handle colllections or disbursment on 50 dollar or 100 dollar loans. It is a time consuming, staff intensive operation and extremely costly in terms of cost per transaction or per dollar lent.

In regards to the usury, my understanding is that Yunus was able to get around the Islamic prohibition of usury by selling the 'interest' as a kind of communal sharing cost so that the program could be extended to their fellow countryme. And considering it is a social venture and all profits are retained I don't think selling it in those terms is necessarily misleading.

I also think you will see more involvement of the capital markets and various bidding systems, maybe something like prosper.com, that will drive the interest rates down.


Interest rates charged by micro-credit institutions reflect the high transaction costs often involved in such activities. To service clients are that are rural, credit officers need to traverse large areas, and collect payments on a daily, weekly or monthly basis. All transactions are in cash and conducted face to face. Institutions looking to be involved in the economic development of a country need to achieve financial sustainability to access commercial credit, freeing them from donor dependency. Compared to other possible lenders for this type of client, rates are very good; moneylenders can charge interest rates that make repayment of the capital impossible.

Part of the problem (IMO) of the ‘microfinance movement’ is its stated aim of targeting the “poorest of the poor” - those with access to sub-US$1 a day. These individuals are the most susceptible to economic upheaval, and who find a change in living circumstances (illness; death; loss of a job) the most detrimental. Loan repayments can here become crippling. Further, in areas without a minimal level of money already circulating in a community, clients find no buyers for their products. No use making sugar cane juice if no one has the money to purchase it.


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