Making Sense of Microcredit Interest Rates

This paper aims to discuss some relevant issues related to microcredit interest rates and the role of donors In particular, the key-points highlighted by this paper are:

• Microcredit interest rates can be higher than bank interest rates because the costs of making a small loan are higher in percentage terms than the costs of making a larger loan;
• In order to reach a good degree of sustainability, MFIs must set interest rates that cover all administrative costs, plus the cost of capital (including inflation), loan losses, and a provision for increasing equity;
• Governments and donors should not subsidize interest rates in microcredit because they distort markets and can encourage rent-seeking;
• Subsidies should be spent during the initial phase of an MFI or to cover operating costs and to develop staff skills.

Finally, the paper provides a list of recommendations to help donors set their interest rates:

• Avoid setting interest rate caps;
• Focus on increasing MFI efficiency;
• Require transparency in financial reporting;
• Support industry infrastructure;
• Support a diversity of institutions.

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