I left you in the last post (#7) with a yawning gap between financing by the most formal providers (banks) and the least formal (friends and relatives), a gap which begs for a hybrid approach. Enter the moneylender – seldom fitting the Shylock stereotype.
The example of the Santa Rosa market in the Philippines indicates the moneylender may be a well-to-do businesswoman who feels an obligation to assist fellow women in business. She may be an entrepreneur with some cash to spare who sees an opportunity to make more money. Not so bad to deal with these fellow Filipinas. They offer more structured access to greater sums than relatives and friends can provide, with much more convenience and flexibility than the stony-hearted banker.
Even the “Bombay five-sixer” is attractive when you don’t want your mother-in-law to know; nobody in your social circle wants to talk to him, so your secret is safe!
Better yet, it turns out that you’ve got room to maneuver when you run into a cash-flow problem. The good-hearted businesswoman’s sense of social obligation is likely to yield to your pleas for more time; she may even let your loan run over its due date without charging additional “interest.” The Indian moneylender doesn’t dare push you too hard, because your cousin and his friends are just looking for a good excuse to run him out of Santa Rosa. The result: if you can negotiate late repayment and even a reduction of interest still due, the effective interest you pay turns out to be a lot less than the nominal interest (a fixed fee, really) stated up front.
Perversely, those who pay the moneylender on time end up paying a higher annual percentage rate than those who delay repayment, because the very high upfront fee gets decoupled from the duration of your loan. Late payment and default are already factored into the moneylender’s fee for service; default rates can be very high (especially for the Indian moneylenders) and renegotiation of loan duration (but not the upfront fee) is surprisingly common.
Tough business, moneylending! Surprisingly unstructured and unpredictable for both sides – mainly because moneylending is so often a “Lone Ranger” operation without much, if any, support infrastructure provided by government or community.
The opportunity for microfinance is in the still-yawning gap between the informal, unpredictable ways of moneylenders and the overly formal and oh-so-predictable ways of traditional banking. Microfinance prospers when it can forge a hybrid that includes the advantages of going to the moneylender and the resources, structure and support systems of the regulated banks and credit unions.
Chapter Five, “The Price of Money,” of Portfolios of the Poor, discusses all the issues regarding the effective interest rate that the poor pay to moneylenders and concludes that the famously usurious interest charged by moneylenders turns out to be roughly only twice the real monetary cost of microfinance loans. Well, that’s still a big difference – microfinance wins the price competition!
Is the price advantage enough to make microfinance a better deal for the poor?