Global Poverty

Interest Rate Stackup: Microcredit v. Credit Cards

Watkins headshot 2by Todd A. Watkins

For a book I’m doing on microfinance, I wanted to get a handle on microcredit interest rates are around the world.  From popular press coverage  over the past 5 years or so on microcredit, we might think the rates outrageously high. Numbers get tossed around like 70% or 100% interest rates. How’s that fair or ethical for rich investors to be charging on tiny loans for some of the world’s poorest people?

But how representative are those numbers?  I wanted to get at the more complex reality in actual practice around the world.

For insight, I went to the Microfinance Information Exchange (MIX), the industry’s leading source of data. The MIX collects data on the return each microfinance institution gets in interest and fees as a percent of its microloan portfolio.  While this differs from the traditional APR calculations used by American banks, the “gross yield on loan portfolio” is a crude approximation of the rate of interest plus fees that microcredit borrowers are paying on average at each institution.

By weighting each institution’s average rate by its number of borrowers, I created the histogram below to show the distribution of how many people are paying what interest rates (including fees). These are real interest rates, i.e. adjusted for inflation, which can vary considerably from developing nation to developing nation. The graph includes roughly 900 MFIs worldwide in 2013-2014. These MFI collectively had nearly 100 million clients across almost 100 countries.

What I end up with is a rough approximation of how high and variable average microcredit real interest rates and fees are around the world. While this technique is unable to capture interest rate variation between different loan products within individual microfinance lenders, the main variation in rates borrowers face is not within institutions, it’s across institutions. Even more importantly, the major variation is differences in loan prices from one country’s markets to another’s.

mfratedist2013a

Data source: Mixmarket.org; Gross Yield on Loan Portfolio (Real), weighted by number of borrowers.

As we see, in real terms, the average (median) microcredit borrower paid about 14.5% in interest and fees. The large majority, about 4 out of every 5 microcredit borrowers worldwide were with institutions charging less than 25% real interest and fees on average. I’ve written about microcredit pricing trends and efficiency in another post.

How high should these rates be, if they are fair? Unlike mortgages and car loans, many microcredit loans are unsecured, not backed by anything but the good will and trust of the loan officer in the borrower. So, for comparison, I wanted to see what Americans were paying on our $700 billion in unsecured loans–on our credit cards.  I went to data collected by the U.S. Federal Reserve Survey of Consumer Finances. I created a histogram constructed in the same scale as my microcredit distribution on the rates American families paid on their credit cards in 2013, the same time frame as my microcredit data.

mfratedist2013cc

Data source: US Federal Reserve, 2013 Survey of Consumer Finances.

I was surprised how remarkably similar the left half of this graph looked to the left half of the first graph. The average (median) family paid 14% APR. Inflation in 2013 in the US was about 1.5%, so the real rate is about 12.5%. The average microcredit borrower paid 14.5%. High compared to mortgage rates we in rich nations pay, sure. But hardly consistent with the image of the evil moneylenders image some of us have of microcredit.

And what about those stories of 70% or 100% rates or more? The bad news is that unfortunately, those seemingly excessive rates do exist. That bump way over to the right of the first histogram represents about 1 in 20 microcredit borrowers worldwide. I’d call that troubling bulge at the tail of the distribution “the Mexico bump.” The very large majority of borrowers paying those way-out-there rates are in Mexico. For some reason, interest rates in the Mexican  microcredit market continue to hover near 60% or 70%, a price point led by the market dominant–and for obvious reasons controversial–Compartamos Banco.

Without that Mexico bump, the world’s microcredit interest rate histogram would look remarkably similar to the US credit card one. In short, for better or worse, most microcredit lenders across 100 of the world’s poorest countries are only about as usury and consumer-abusive as American banks’ credit cards in one of the world’s richest societies.

Shylocks?

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