The Interest Rate Debate: How is Oikocredit Protecting Clients?

August 9, 2011 at 6:21 PM - by Leah Gage - 0 comments

You’ve probably heard about the debate surrounding interest rates on microfinance loans, with the center of focus hitting Indian microfinance institutions in the past year. Allegations of greed in loan pricing and borrower over-indebtedness have caused the Indian government to tighten its regulation of the microfinance sector. The government has placed microfinance institutions under the supervision of the Reserve Bank of India (RBI) through a new bill that is creating controversy among some and a sense of reassurance among others.

However, you may not know what the industry is doing to respond to these concerns, what Oikocredit is doing to ensure transparent pricing for end-borrowers, or even how interest rates are calculated in the field.

So let’s take a deeper look: What is an interest rate, and why are high interest rates the topic of such heated debate?

An interest rate on a loan is the amount of interest (%) paid by the borrower for the use of the money they have borrowed. Calculating the interest rate using the TCC can be misleading, while using APR is beneficial to the borrower by allowing for cash flow fluctuations and reducing payments as the loan approaches maturity.

Putting prices in terms of APRs is simpler and easier for the client, who may be illiterate or uneducated. Using APRs, all she has to understand is that more is more and less is less. The switch to calculating interest with APR is an important part of increasing pricing transparency. Although APR is a standard way to calculate loan prices in the banking industry, some MFIs still use the total cost of credit to inform clients about loan pricing.

Loan pricing, especially in microfinance, is a complicated issue because of the variety of factors affecting that price: the loan size, a client’s credit history, transaction costs, the repayment schedule, required savings, expensive labor markets, inflation, Value-Added Taxes (VATs), government regulation and interest rate caps, the maturity of the MFI, and their individual definition of “responsible pricing” according to that country.  All of these costs are passed on to the borrower, and all can drastically affect the price of her loan.

As a microfinance investment fund, Oikocredit is dedicated to “investing in people” and promoting financial inclusion. We are committed to the double-bottom line and view all issues negatively affecting the welfare of clients as potential risks for all stakeholders in the sector. We take pricing transparency as a serious matter. To that end, we maintain an internal database of prices charged by MFIs within a given country for comparative purposes and also benchmark partners using data collected by MicroFinance Transparency.

Since we provide patient capital and are committed to long-term interest of our MFI partners and the 29.3 million clients reached through our portfolio, we also believe it is our responsibility to play an advocacy role. As such, we encourage our partners to publish the pricing of their products and today over 55% report their interest rates to the MIX Market site (www.mixmarket.org).