Interest Rates and Pricing

The price of a financial service varies depending on the product, the institution, the context in which the institution operates, and the institution’s profit expectations. Most financial institutions strive to cover their costs through fees and interest charged to users, but when dealing with low-income consumers, the question often arises as to how much profit, if any, is acceptable.

For microloans, interest rates are typically higher than the bank interest rates that wealthier people pay. The issue largely revolves around cost: it takes a lot less staff time to make a single loan of US$100,000 than it does to make 1,000 loans of US$100 each, so the administrative cost of a small loan is much higher as a percentage of loan size. In addition, credit decisions for borrowers without collateral or a salary cannot easily be based on automated scoring, so these decisions require substantial involvement by a loan officer who must judge the risk of each loan. Many microfinance institutions operate in areas that are remote or have low population density, making lending even more expensive.

To be sustainable, institutions must price their products high enough to cover their costs. Many institutions working with poor people strive to maximize their operating efficiency to keep costs low, and seek to achieve an appropriate balance between the price they need to cover costs and the price the client can afford to pay. Approaches to pricing and profit vary depending on the organization’s motivations and have been widely debated. Concerns about high profits in microlending sparked several international efforts to improve pricing transparency and introduce consumer protection policy to enable consumers to make informed decisions. 

Interest rate document from Cambodia - Credit: Brett Epic