Understanding and Dealing With High Interest Rates on Microcredit: A Note to Policy Makers in the Asia and Pacific Region

This paper argues that imposing a ceiling on microcredit interest rates would hurt the poor. It points towards a number of positive measures that policy makers could consider to bring down the high microcredit interest rates without hurting the industry and its clients. The paper presents the following main arguments:

• Charging prices high enough to cover costs is essential for a business to continue operations beyond the short-term;
• Concessional funds are not a permanent source of funds for microfinance institutions (MFIs) and provision must be made through interest rates to sustain the lender's operations;
• Lenders will incur losses if the rate ceiling is less than that required for cost recovery;
• Empirical evidence supports the view that liberal interest rate policies fuel the growth of the microfinance industry;
• In countries with interest rate ceilings, the growth of outreach has been disappointingly low.

The paper offers the following suggestions for policy makers:

• In a developing economy, the best available investment opportunities for a majority of poor households involve those with moderate returns;
• A clear policy statement from governments, assuring that interest rate ceilings on microcredit will not be imposed, would eliminate a significant policy risk;
• Governments should seek consultation with MFIs to understand the infrastructure bottlenecks that thwart their activities, and endeavour to improve such infrastructure;
• Separating fundamental causes from proximate causes of high interest rates is critically important for designing appropriate interventions.