Hey, it’s expensive to serve the poor! Anyway, the other guys are charging even more, a lot more.
Doesn’t this feel like a pretty weak defense of high interest rates in microfinance? The “other guys” charge even more? Even a purely commercial microfinancier suffers some embarrassment from this conundrum in microfinance—the poor have to pay more than the better off. There’s got to be a better way to explain ourselves. This demands deeper understanding of the context for microfinance providers.
Let’s take a look at a specific market in Santa Rosa, Laguna province in the Philippines, thanks to a study nicely reported by Mari Kondo. In the interview period, 2000-2003, there were 450 vendors in this very active provincial public market only an hour or two from Manila, 75 percent of them women. A bit over half were “ambulant vendors” who included the poorest vendors in the market. They sold
“smoked fish, vegetables, fish balls, and the like. Unable to buy or rent a stall, they market their goods along the sidewalks, in front of the larger stalls, or at the back of the market near the fish and meat vendors. Many are wives of fishermen living along the coast or of small farmers who sell their own harvest supplemented with fish bought from other, cheaper markets. The ambulant vendors are those most in need of informal financing. If they cannot sell enough one day, they need capital in order to buy goods to sell in the market the next day.”
Despite the presence of a variety of formal lenders—cooperatives and rural banks (including Freedom from Hunger’s partner CARD Bank)—and pawnshops, the vendors of all types raised working capital mostly from their own businesses and informal financiers: the “five-sixers,” so called because a five-peso loan is repaid with six pesos—20% interest.
If you took such a loan for a week, your annual percentage rate (APR) of interest would be well over 500%! More typically a loan to a vendor is 10,000 pesos for 80 days, with a daily payment of 150 pesos, which works out to 20% again, but a much lower APR because of the longer timeframe. Hold this thought while I share a bit about the moneylenders themselves.
There were 20-25 Filipino five-sixers operating in the Santa Rosa market, mostly women, many middle-class, long-time residents of Santa Rosa. Some had other successful businesses, but the “small-timers” entered the 5-6 business to invest money earned overseas.
In addition, there were 15-20 Indian five-sixers, mostly men and Sikhs (and mostly illegal immigrants) who were regarded very unfavorably by Filipinos as “Bombay Five-Sixers.” But they brought capital from India and served as the lender of last resort for the vendors. The Filipinos were embedded as community insiders while the Indians were definitely outsiders.
Mari Kondo’s report tells a fascinating story of what the 5-6 business was like for these two very different types of people—a real eye-opener for those who know as little about moneylenders as I did.
Even more interesting:
“Filipino 5-6s frequently use the mutual help scheme paluwagan to generate funds for their 5-6 business and at the same time check the credibility of their clients. The paluwagan is a kind of rotating savings and credit association: a group of people contribute the same amount of money toward a common fund and take turns collecting the total, often called the “salary,” over a fixed period (e.g., every seven days, every thirty days). The paluwagan is a common mechanism for saving money among Filipinos who do not enjoy access to banks.
A paluwagan scheme at the Santa Rosa public market typically involves five or ten stall vendors contributing over a period of months – five months if five members, ten months if ten members. Some paluwagan are much shorter – four members contributing for one month – so that the collected money is received weekly. The Filipino 5-6 moneylender usually serves as “manager” of the funds, collecting paluwagan contributions daily together with 5-6-loan payments. To compensate for the extra service involved in collecting the paluwagan money, managers “pocket” the payment of the last day of the month (1/30 or 3.3 percent of the amount collected). Members draw lots to decide who will receive the salary first, with earlier payment more advantageous. In some cases, the manager reserves the right to withdraw the salary first and uses the money to support her 5-6 business. In both cases, paluwagan members pay extra (or negative interest) to gain access to a savings mechanism provided by the Filipino 5-6 moneylender.”
The example of this particular community and market in the Philippines reinforces the points made in Portfolios of the Poor, especially in Chapter Five “The Price of Money.”
First, annualized interest rates (APR) are really unhelpful for understanding what is going on. It is better to think of the “interest” charge as a fixed fee for borrowing a certain amount for a certain period of time.
Second, while the poor are sensitive to price, they are far more sensitive to convenience, flexibility and reliability of access to the right amount of money at the right time. Repayment is all about cash flow being adequate to make each of the installment payments on time.
Third, the poor have to be able to pay in tiny installments, whether to repay a loan or build savings. Borrowing and saving feel very similar in the routine of their lives.
Fourth, moneylenders are often thoroughly embedded in the communities of the borrowers, which persuades or forces the moneylender to be more sympathetic and therefore flexible than formal financiers, resulting in effective (real) interest rates well below the nominal (stated) interest rates. The moneylenders are often struggling, too.
I’ll build out these points in the next post. Meanwhile, can you offer or point to other well-documented examples like this one from Santa Rosa in the Philippines? I found a good but brief study of Ugandan moneylenders, reported by Kaffu and Rippey, which paints a similar picture. Most reports are about Asian moneylenders. Are there others from Africa? How about Latin America?