Microcredit Interest Rates (Occassional Paper No. 01)
Rosenberg, R.
Publication Date: Nov 2002
Published by: Consultative Group to Assist the Poor (CGAP)
Document Type: Paper
How high must the interest rate be to ensure sustainability? And will poor clients be able to pay this rate?
Presents how to set a sustainable interest rate and shows how effective interest rates can be raised
Sustainable interest rates are set as a function of five elements, each expressed as a percentage of average outstanding loan portfolio: - administrative expenses
- loan losses
- the cost of funds
- the desired capitalisation rate
- investment income
- computation of each element is explained.
Methods to raise the effective interest rates include: - computing interest on the original face amount of the loan, rather than on the declining balance, as successive installments of principal are repaid (this method is called a "flat" interest charge)
- requiring payment of interest at the beginning of the loan (as a deduction from the amount of principal disbursed to the borrower), rather than spreading interest payments throughout the life of the loan
- charging a "commission" or "fee" in addition to the interest
- quoting a monthly interest rate, but collecting principal and interest weekly, counting four weeks as a "month"
- requiring that a portion of the loan amount be deposited with the lender as compulsory savings or a compensating balance
Concludes that MFIs should preferably charge clients with an rate high enough to ensure their own sustainability than deliver subsidised credit. [author]
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