On the heels of the recent NYTimes article about high interest rates in microfinance and with the Microfinance USA a few days away where one of the most anticipated sessions is entitled "What is a Fair Price to Pay for Good Credit," Chapter 5 was another perfectly timed chapter of Portfolios of the Poor.
Consistent with their earlier chapters, the authors introduce us to this thorny issue by allowing us to see the issue from the perspective of the client. When doing so, it turns out that pricing does not dominate the discussion like it does for microfinance practitioners. Instead, price is one factor that households consider when they access a service. Other factors that are equally important are convenience, timing, and repayment flexibility. In addition, the authors suggest that thinking of interest rates as fees also breaks the discussion away from the inevitable comparison with market interest rates.
I also appreciate how the authors introduce other dynamics into the pricing equation. When I spent time in Ghana as a Kiva Fellow, I quickly understood the reality of servicing loans to rural communities. But, this chapter deepens this analysis by also introducing other reasons for higher prices including, the short-term nature of lending, the relatively small size of the principal, the lack of compounding interest, and the flexibility of arrangements.
When I view the U.S. experience through the lens of this chapter, I'm immediately reminded of the intense advocacy for interest-rate caps for payday lenders. Interestingly, the POTP authors suggest that interest-rate caps are not effective and would put many pro-poor MFIs out of business. This would send many a well-intentioned lobbyist into fits here in the U.S. I wonder what their position would be for the U.S?
I think that would depend on whether price is the only factor at play in the U.S. In addressing the price issue, the POTP authors spend some time explaining why price is central to loans here in the U.S. With our more sophisticated financial markets and reduced transaction costs, price plays a central role and comparing interest-rates between institutions is a fair comparison (The POTP authors emphasize that making interest rate comparisons between developed markets and developing markets is not a fair comparison). If we can assume that all products are equal in terms of other factors like convenience and flexibility than perhaps we should focus efforts on making sure interest-rates are not priced to take advantage of certain customers.
However, I do believe that one of the reasons for the growth of the payday industry is their recognition that in the U.S. many customers, like the POTP households, also consider convenience and repayment schedules when they take a loan. That's why I'm especially heartened to learn more about small-dollar loans that are being introduced in banks across the U.S through the Bank On initiatives and with the help of the FDIC's Small Dollar Loan program. If regulated banks and credit unions can be as convenient, flexible, and consumer friendly as the payday lenders, then we may see competition solely on price and hopefully interest-rates will decline without needing interest-rate caps.
But, until then the debate continues and I'm looking forward to the Thursday session at Microfinance USA!
There is no question in my mind that fierce competiton amongst multiple lenders is the best way to bring about interest rate reduction and not regulatory dictat. However, what is not clear to me is why, despite the presence of many MFIs in a particular region, MFIs choose to compete by lowering process discpline / underwriting standards but not using interest rate reduction.
ReplyDeleteChoudhry and Rai of IFMR Trust (www.ifmrtrust.co.in) in Chennai find that there is an "excess" lending spread / profit margin of almost 16% in Indian MFI lendings rates (http://bit.ly/Nvw6k) even after accounting for all the costs of doing business and that the margin of 15% over costs that Professor Yunus recommends is perhaps 10% too high in the South Asian / Indian environment. However, competitive forces seem to allow these margins to remain and not push them down as they would have in other industries.
Professors Pingali and Lahkar of IFMR (www.ifmr.ac.in) have now begun a systematic Industrial Organisation project to try and understand why such an equilibrium obtains and what can be done to shift the current state of affairs to a lower interest rate equilibrium.
Whenever i see the post like your's i feel that there are still helpful people who share information for the help of others, it must be helpful for other's. thanx and good job.
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