Why Are Microfinance Interest Rates So High?

nature is inefficient — that’s why banks and other institutions have stayed away. Banks usually make loans in denominations of tens or hundreds of thousands of dollars. As mentioned before, the average microloan is around 0. A microfinance institution would have to make 100 loans to equal a ,000 bank loan, so a microfinance institution would have to operate 100 times as efficiently in order to match the same cost as a bank for deploying ,000.

So we would expect it to be more expensive to service microfinance borrowers, but is any of this expense due to waste? Let’s have a look at how microfinance institutions operate. According to the MIX, the average loan officer in the microfinance industry manages 252 loans for 245 different borrowers. The average salary for a loan officer is around three times the gross national income per capita of the country in which they work. When you translate the average gross national income for the sample that the MIX is using, that salary comes to around ,300.

According to Salary.com, the average salary of a commercial loan officer in the United States is around ,000. So although a microfinance loan officer may be three times as well off as their average countrymen, their salaries are still well behind those of developed nations.

The Bottom Line

So if we add up all these expenses — financial expense, loan loss reserve, administrative expense and personnel expenses — what are we left with? Of the 30.7% interest rate that we started with, 26.3 percentage points are expenses, leaving us with about 4.4 percentage points of profit. Those 4.4 percentage points result in a net profit margin of around 14%. Is that too much profit?

In many ways, such a question is rhetorical. Profit margins of many large banks in the United States are north of 20%, so relatively speaking, microfinance profit margins are much lower.

Bringing it all together, the components of microfinance interest rates are as follows:

Component, Percentage Points, % Total

Financial Expense, 6.7%, 21.7%
Loan Loss Reserve Expense, 1.4%, 4.6%
Administrative Expense, 8.1%, 26.5%
Personnel Expenses, 10.1%, 33.0%
Profit, 4.4%, 14.2%
Total Interest Rate, 30.7%, 100.0%

These calculations may indeed be back-of-the-envelope, but they are accurate enough to get to the point. The simple answer to the question “Why are microfinance interest rates so high?,” is that “the loans are so small.” Of all the components mentioned above, the ones that stick out as extraordinarily high are administrative and personnel expenses.

But when you consider that the average number of loans outstanding for a microfinance institution is over 8,000 and the average portfolio size is only .6 million, you realize that it’s going to take a lot of work to service all those loans. Furthermore, there’s not a lot of money being lent out, so the interest rate has to get higher to cover that cost. It’s as simple as that.

There may be a lot of factors that contribute to the microfinance interest rate, but they become pretty insignificant in the face of operating costs for all those loans. So next time you consider providing money to microfinance organizations, don’t just think about the interest rate to the borrower (which is still better than the alternative). Think about all the work and effort that the microfinance institutions themselves perform in order to achieve that rate.

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