by Lynne Davidson Jarrell
I asked Lynne to summarize the posts under Theme Two, from her perspective rather than mine. Note that she points to the posts relevant to each topic she covers (the numbers are hyperlinks). Each post on this blog is assigned a unique number in chronological order of posting, and all the posts for each theme are listed by number and title on the right side of this page under “View by Theme.” Next week I will discuss what Theme Two means for Freedom from Hunger. Then on to Theme Three!
Are clients of microfinance providers borrowing or saving money at better interest rates than they could obtain otherwise?
The evidence suggests that microfinance interest rates on loans are considerably lower than those charged by typical moneylenders. But there is much more to understanding the true “cost” of borrowing (or saving) than simply knowing the stated interest rate. Before one can determine which option is the “better deal,” we need to know more about the process by which those deals are made, and the structure of the deals (see posts 4, 6, 7, and 8).
Six Factors that Matter
What are the advantages and disadvantages to the clients of formal banking institutions v. less formal moneylenders, family and friends v. microfinance institutions? We see at least six factors that matter to the clients.
Let’s look at the evidence regarding each of these factors.
1. We need to know more than the annualized interest rates
The interest rates that moneylenders appear to charge can be considerably higher than those of the more formal lending institutions, including microfinance institutions. However, because of the personal contact between moneylenders and their clients, rates and payment schedules can and do get renegotiated. It may be that the only ones paying the very high APRs are those who pay on time (see post 8).
Further, because loans from moneylenders are often very short-term, even very high annual rates can translate into very small sums.
Consequently, the advantage that microfinance providers have over moneylenders with respect to interest rates is likely considerably less than it appears.
2. Convenience, flexibility, and reliability matter
Inconvenience means that transactions involve additional costs beyond interest and fees. Banks impose a great deal of inconvenience on their clients, while moneylenders (and, perhaps to a lesser extent, microfinanciers) can almost completely avoid such transaction costs as travel, burdensome paperwork, etc. These and opportunity costs (e.g., when a loan approval takes too long to be useful) can add considerably to what the clients perceive as the true costs of a financial transaction (see posts 6 and 10).
The evidence regarding flexibility also seems to favor the less formal loan options, with moneylenders showing much more flexibility than banks and somewhat more flexibility than microfinanciers, regarding loan size, need for guarantees, and repayment structures (see posts 6 and 10).
The evidence on reliability supports a preliminary conclusion that MFI clients experience greater reliability within the structure of the microfinance product than with the informal moneylenders (see post 4).
Privacy also seems to be enhanced by dealing with microfinanciers compared to moneylenders (see post 4).
3. The option to pay back in very small sums is critical
Microfinance loans are generally very structured, with little, if any, room for negotiating changes to payment schedules. The frequency of repayments is high, but the size of each payment is small. Although the frequency may be problematic for borrowers, especially those early repayments that come before the client has had a chance to reap any benefits from the loan itself, the small amount of each installment can make such loan repayment schemes a better match to the cash flow of the borrower. The formal banker cannot offer a product that is so clearly congruent with the cash flow of our target population. The informal moneylender can alter payment schedules to allow for smaller payments, but the borrower may do so at the risk of higher interest costs. So the evidence on payment size favors microfinanciers, but informal lenders can and do compete with MFIs on this factor (see posts 8 and 9).
4. Lenders in the community can be more sympathetic to client needs
The borrowers find benefits in going to lenders who are in and of their same community, They seem willing to pay considerably more just to have a lender who understands the community within which he operates, because he is more likely to be sympathetic to the idiosyncratic needs of each borrower. Conversely, community lenders have an advantage in gathering information about potential borrowers. They can more easily avoid potential defaulters, thereby requiring a smaller default cushion in their interest rates and minimizing guarantee requirements.
5. Groups create benefits that don’t exist in one-on-one transactions
We know that borrowers may experience costs and benefits that come from just their participation in microfinance groups (including savings groups). There are benefits of group membership that are unrelated to benefits from the financial services or the education sessions associated with the loan. These benefits include moral support found in the group setting (e.g., members of the group “have become family”) and the opportunity to socialize. When field agents are trained and supervised to engage their groups in non-formal adult education, the relationship between the external organization and the group members seems qualitatively more “caring” in the eyes of clients, leading to greater client satisfaction and loyalty to her group, the field agent and the external organization supporting the field agent (see posts 12, 13, 14 and 15).
6. Imposed discipline can be a major benefit
The rigid repayment schedule may be a severe cost imposed by the microfinancier, but it also may be appreciated by the poor for the discipline required to comply with such a schedule. This imposed discipline may be especially beneficial in commitment savings groups (see posts 12 and 15).
The Importance of Choice
While it may be tempting to conclude that microfinanciers “win” on more of the six factors than the other options do, and therefore offer the best deal to our target populations, perhaps a safer conclusion is that the poor are better off when they have more choices, including microfinance. Different options will be preferred depending upon the circumstances. When a quick loan is in order for, say, a medical emergency, the borrower may prefer the most informal option because of the speed with which she can obtain the money. If the goal is to (slowly) build a small business, the reliability of a microfinance institution, with its system of support, might be preferred (see posts 9 and 14).
Of course, the target population cannot “get a better deal” if there is no deal to be had. There are many, especially rural, situations where there are virtually no borrowing opportunities at all. If it were not for social goals motivating microfinanciers to test the frontiers of profitability and beyond, many of the poor would have no financial service deal at all (see post 11).
An aside on savings groups
Further regarding choice, we must consider the relative advantages of the modern savings group program. Participants in savings groups seem to enjoy many of the same benefits as members of credit groups supported by microfinance institutions (e.g., easy access to loans, imposed discipline, group support) but also more autonomy for group self-management, savings opportunities and substantial return on savings due to lending from the group savings pool. While the evidence does not yet allow detailed comparison of the benefits of such savings groups with traditional savings groups and credit groups, we soon may learn from research in progress, as Laura Fleischer Proaño describes in her comment, “that the social and financial [aspects of savings groups] reinforce each other” (see post 14).