Are microfinance interest rates too high?

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Why do microfinance institutions (MFIs) charge such high interest rates? Nimal Fernando tackles the problem in a new ADB paper targeting policymakers in Asia. From MicroCapital blog:

Interest charged on loans is the main source of income for MFIs. Thus they must be high enough to cover operational costs. Since microlending remains a high-cost operation, interest rates remain high. Mr. Fernando reports that MFIs in the Asia-Pacific region charge rates ranging from 30 to 70% a year. However, he goes on to say that it is important to remember that comparisons with rates charged by commercial banks are inappropriate. In that case, larger loans mean lower transaction costs and result in lower interest rates.

The paper is in line with current thinking that ceilings on microfinance interest rates will only hurt the poor. Evidence from Nicaragua, South Africa and Armenia suggests that MFIs will react to such rate caps by either withdrawing from poor areas or adding extra fees or, more likely, both. So what’s the answer? Competition should be enough to drive down these rates, especially if coupled with moves to help consumers comparison shop.

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