Flat interest rates are the current controversy raging on the microfinance community listserv. This is a highly widespread and dubious practice in microfinance. Flat rates cost the borrower more than the standard declining interest rate – but the micro-enterprise owner is often in the dark about this reality. With flat interest rates, each month’s interest is charged on the original amount of the loan. Declining interest rates vary in that interest is charged according to how much of the original loan remains in the borrower’s hands, which shrinks as successive payments are made. Although common in microfinance, flat interest rates are not the banking standard in the developing world, so often when a microfinance institution quotes a 2% monthly interest rate to its customers, the actual rate of interest is much higher. How much higher depends on the term of the loan, but the actual rate can easily be twice as high.

Because clients are often illiterate and financially inexperienced (or too trusting of the local NGO), flat interest rates sound appealing. And in addition to the larger interest payments that come with flat rates, they are easier for microfinance institutions to calculate. For these reasons, flat interest rates have been seized upon, but at the expense of the unsuspecting borrower.

Bottom line: not only are customers deceived, but microfinance institutions that use the standard declining rate are at a significant disadvantage. Equally insidious, microfinance institutions quote these flat rates to donors who fall for the same trick as the micro-enterprise owners.

Not surprisingly, there are plenty of defenders of flat rates in the donor community. The reasons range: "German mortgages are written using flat rates too;" "a top microfinance institution in India, ICICI, uses flat rates;" "small microfinance institutions do not have the infrastructure to calculate declining rates." While all this may be true, it is a well-known fact in the microlending trenches that flat rates deceive customers. Of course, there are many examples of firms responsibly using flat rates, but that is not the point. The point is that your tax and charity dollars are often being used to gouge the global poor.

Additional Resources

1) US Agency for International Development (USAID): "Calculating Effective Interest Rates on Microcredit Loans."
2) Consultative Group to Assist the Poor (CGAP): "Microcredit Interest Rates."3) Information from the Consultative Group to Assist the Poor (CGAP) regarding potential disparity between flat and declining interest rates in terms of annual return on loans

A “socially-responsible investment” (SRI) mutual fund (ticker: FEMXX) that screens companies according to how they treat women has spilled over into the domain of capital markets for microfinance. With Walden Asset Management ($1.3 billion in assets), a subdivision of Boston Trust ($3.7 billion in assets) acting as sub-advisor, the fund manages $33 million in assets, of which approximately 2%, or $500,000, was part of the recent offering made by Blue Orchard Finance, the first fully commercial investment fund.

Within the past year, the women’s equity mutual fund has “implemented perhaps its most innovative strategy by investing in microfinance” so that “more funding in the capital markets [will be] directed into microfinance.” This represents a logical progression considering the complementary objectives of the women’s equity fund and microfinance, where the majority of customers are women.

Additional Resources
1) Walden Asset Management
2) Article: "Women’s Equity Mutual Fund Supports Businesswomen Through Screening and Now Microfinance."

The non-profit organization PlaNet Finance just announed the launch of PlaNet Bank, a new global investment company for microfinance institutions. The International Finance Corporation (IFC) was the lead investor with $7.3 million. The new investment vehicle intends to “create or invest in 15 microfinance institutions over the next five years,” with at least 60% of these envisioned microfinance institutions (MFIs) in Africa.

The bank will be capitalized at $38 million, signifying a substantial addition to the worldwide microfinance investment climate, in which commercial and (mostly) quasi-commercial investment approximate $1.9 billion. Last year, the launch of a fund of a similar size caused a significant spike on our MicroCapital Index. Though not in our index, PlaNet Bank is now in the top tier of microfinance investment vehicles in terms of asset footings.

The IFC is one of the world’s largest investors in commercial microfinance, with a worldwide microfinance portfolio of more than $260 million. PlaNet Finance has invested over $300 million generally, $220 million of which was allocated to microfinance.Additional Resources1) Press Release: "IFC Invests in New Africa-Focused Microfinance Initiative."
2) International Finance Corporation (IFC) Summary of the PlaNet Bank project3) PlaNet Finance’s Annual Report FY 2004

Last week, Hewlett-Packard (HP) and Accion International announced the global release of an elaborate software that will perform rural loan transaction over mobile phones. The Remote Transaction System (RTS) is a “cost-effective means of tracking loan information” that will soon have an open source aspect. The announcement culminates the collaborative efforts of HP and multiple microfinance entities working to develop the software.

Banking software tailored to microfinance of course exists, but there is no industry standard. The World Bank microfinance unit (CGAP) lists over 50 such applications on its website, 15 of which are reviewed. To date, however, no one has tried an open source approach. Because most of the world’s 10,000 microfinance institutions (MFIs) are unprofitable, the firms that make the software products for MFIs are under-funded and often subsidized themselves. Revenue has historically been insufficient to support a better product, leaving the microfinance industry in need of an efficient, standardized approach to banking software.

The RTS innovation will hopefully succeed on both accounts, allowing for the creation of an industry standard and also achieving a “breakthrough in the scale of microfinance services,” because only open source might be affordable for all those tiny, cash-strapped microfinance institutions out there.

Will this open source development create an industry standard? A standard is certainly needed. Banking software taken downstream to service microfinance is just too expensive to buy and maintain for most micro-lenders, while on the other hand, the new products from technology firms focused on microfinance are limited in the face of microfinance market challenges, namely varying language, regulation, maintenance (infrastructure is scarce) and of course, cost.

Might an open source solution be affordable? Establishing a standard will depend on how cost-effectively on-site technicians can manage the application. Open source is not by definition cheaper of course. It is all about execution.

Again and again in the emerging microfinance market we are left with the same conclusion: many of the pieces are in place for an asset class, now it is up to local talent to see it through.

Additional Resources1) HP News Release
2) More in depth article by the UN Capital Development Fund’s Microfinance Matters
3) Sevak Solutions, which holds the rights to the RTS technology and licenses these rights to interested parties

Inspired by Wall Street, the World Food Program is creating weather derivatives, a sophisticated financial instrument that would insure Ethiopian farmers against harvest failures caused by droughts. Applying high finance to the risk that millions lose their lives to drought guarantees that funds will reach Ethiopia within a few weeks. Market mechanisms are a more cost-effective way to protect people from drought. Microfinance leaders BASIX and ICICI are using similar products successfully.

1) “Can Insurance Break Ethiopia’s Vicious Cycle Of Hunger?”2) World Bank (WB): “Piloting Weather Insurance in India.”
3) Subscription only: “Basix India Distributes Agri-Insurance.” India Business Insight. Dec 2003. pg. 53

An American company, Wyse Technology is working with Indian consulting company Comat Technologies to bring computer kiosks to 5000 villages around the Indian state of Karnataka. The ICICI Bank, Indian government, and the International Finance Corporation (IFC), which is a division of the World Bank (WB), will also participate. Six to ten networked terminals containing information about education, healthcare and land records will be set up in each village.

Harvard Business School (HBS), in collaboration with ACCION International, one of the world’s largest microfinance networks, will be launching the first Program on Strategic Leadership for Microfinance from April 17 through April 22, 2006. Industry leaders and executives from all over the world will network with one another and take classes from HBS faculty in the areas of business strategy and management. ACCION International will be posting applications on its website in July. Applicants must be fluent in English.

We applaud an effort that addresses the weak link in the microfinance value chain: local management talent.

Jean-Philippe De Schrevel of BlueOrchard Finance, a microfinance asset management company, has hit the bull’s eye when he explains in the current Asian Development Bank newsletter how the financing of microfinance institutions (MFIs) should be left to the capital markets, rather than donations or public funds. Public and charitable funds should be re-directed to:
1) Auditing and regulatory standards 2) Strong financial infrastructure such as supervisory authorities and research institutions 3) Credit rating agencies and standards
4) New financial products, such as those that hedge foreign exchange or political risk
5) Subordinated tranches of investment funds, while leaving the senior tranches to private investors.

Overall, governments and non-profits should not give away their money to MFIs, but responsibly fund the infrastructure for an emerging market and asset class.
Additional Resources
1) Newsletter: “Finance for the Poor," Kathryn Imboden2) Subscription only: "Building Inclusive Financial Sectors: the Road to Growth and Poverty Reduction." Journal of International Affairs. Spring 2005. Vol 58, Issue 23) Subscription only: “Crawford’s Minifund for Microlenders.” Institutional Investor. Feb 2004. pg. 14) Subscription only: “Microfinance Break.” Latin Finance. Feb 2005. pg.1

"….it may be better to direct money [rich country aid] to charities or to schemes such as microcredit, which loan people money to help themselves, than to governments."

Rich countries re-directing their ‘aid’ from African governments to microfinance organizations is not a solution, but rather, part of the problem. Indeed, most of the money already in microfinance originates from government funding. What would be the point in diverting money from inefficiently-run governments to inefficiently-run microfinance institutions (African Business). A more effective use of this ‘aid’ would be to invest it into private sector intermediaries such as the funds MicroCapital lists, in which investors hold fund managers accountable. Indeed, it is the sad performance of government bureaucrats picking and choosing which microbanks to fund over the past 20 years which has created the current situation: 10,000 micro-banks around the world, but less than 300 that are financially viable. When will it end?

1) Games, Dianna. "Mobilising Africa‘s untapped potential." African Business. London: May 2004. Issue 298. pg. 18
2) "Micro Loans, Solid Returns; Microfinance Funds Lift Poor Entrepreneurs — and Benefit Investors." Business Week. May 2005. Vol. 3932, pg.100. Uhlfelder, Eric and Ilma Ajanovic
3) Article referenced above: African Business. Issue 298. Pg. 18

Continue reading “The MicroCapital Blog Authors”