Key finding: Policymakers have been concerned about the effects of the seemingly high interest rates typically charged by microfinance institutions (MFI) lending money to poor people. Available data indicates that microfinance interest rates typically fall between 20 and 50 per cent per year (in places where inflation runs no higher than 10 per cent per year). It has been argued that such interest rates can erode surpluses generated by borrowers, leaving them with little net gain.
But whilst experts agree that high interest rates intuitively make it more difficult for poor people to repay micro loans, in practice there is little evidence of these effects, and little research has been done in this area. Moreover, the literature concerned with the ‘fairness’ of interest rates has largely adopted a supply-side perspective. It focuses on factors affecting the pricing of loans, typically using large-scale comparative data to assess what is and is not an acceptable level of profit for MFIs and establish whether or not the poor are being exploited by rates charged.
The limited available literature on the impact of interest rates from the borrower perspective tends to focus on two main issues: the effects of high interest rates on demand for microcredit (or credit elasticity), and the effects on over-indebtedness. In both instances, research mainly takes the form of country-specific case studies.
This report is organised in three sections:
- it summarises the main factors seen to affect interest rates in the microfinance sector from a supply perspective
- it presents available case study evidence of the impact of interest rates on borrowers
- it synthesises the debate about whether or not capping rates is an appropriate policy response and presents some evidence of the impact of caps where they have been implemented.