By Chuck Waterfield, Published by MicroFinance Transparency, June 2011, 10 pages, http://www.microfinancegateway.org/gm/document-1.1.9115/The-Challenge-of-Understanding-Pricing-of-Micro-Loans_Jun2011_ENG.pdf.
This article explores the difficulties in understanding and comparing interest rates charged by microfinance institutions (MFIs), using Compartamos Banco of Mexico as its main example. The report cites as key challenges the lack of regulations requiring transparency in many countries where MFIs operate and the misrepresentation of interest rates by some MFI staff.
In the example of Compartamos, a Mexican microfinance bank founded in 1990, the bank communicates an interest rate of 4 percent per month to its clients, but charges 105 percent interest if calculated on an annual percentage rate (APR) method and over 150 percent when calculated using an effective interest rate (EIR) formula. According to information given by Compartamos to its clients, for a loan of MXN 3,000 (USD 300), borrowers will make equal payments of MXN 221.68 (USD 22) per week for 16 weeks for a total of MXN 3,547 (USD 355) on an average loan balance of MXN 1,300 (USD 130). Mr Waterfield points out that if a client continues to take out loans and repay them for a full year the client will pay MXN 1,794 (USD 180) in interest on an average loan balance of MXN 1,300 (USD 130).
The paper calls attention to the fact that Compartamos charges “flat-rate” interest, meaning borrowers are charged interest on the full amount of the loan each week even after they have repaid part of the balance. This contrasts with the “declining-balance” method, which involves calculating interest each period on only the outstanding loan balance. Taking into account the charging of flat-rate interest by Compartamos, the annual interest rate reaches 86 percent, rather than the 48 percent that might be expected from its claim to charge four percent interest per month. In addition, Compartamos actually charges four percent flat interest every four weeks, not every month, which allows the bank to charge clients an extra “month” of interest each year. According to MFTransparency’s calculations, this raises the APR from 86 to 93.7 percent.
Compartamos also requires borrowers to save ten percent of their loan balance, MXN 300 (USD 30), as soon as they receive the loan. If the borrower fails to pay, Compartamos seizes the money. Although borrowers never effectively receive the complete amount of their loan they are still charged interest on this money. In addition to these factors, many MFIs charge fees and commissions. Compartamos does not claim to charge any fees on the repayment schedules on its website, but it does charge the 15 percent value-added tax required by the Mexican government. This tax adds 13.4 percent to the APR, bringing it to 107 percent, which is approximately what Compartamos reports in the fine print of its repayment schedules posted on their website.
The report concludes that because of the challenges in calculating interest prices, it is common for MFIs to charge rates that are much higher than they appear. While truth-in-lending laws can help with this problem, in many countries where MFIs operate transparency laws are not in place. The author argues that it is essential to increase transparency worldwide to keep borrowers informed of the true cost of loans and allow them to make better choices about the funds they borrow.
By Charlotte Newman, Research Associate
MFTransparency is a US-based nongovernmental organization (NGO) that was launched in July 2008 to provide information on microcredit products and their prices. MFTransparency collects data on the interest and fees charged on microfinance loan products in order to calculate and publicize the effective interest rates charged on those loans. According to its website, 889 industry stakeholders have endorsed its efforts as of 2011. As of January 2012, MFTransparency has collected data from about 30 countries on four continents, including 16 countries in Sub-Saharan Africa.
About Compartamos Banco
Compartamos Banco is a microfinance bank based in Mexico that was founded in 1990. It offers group and individual loans in rural and urban areas. Compartamos Banco provides loans to people with low-incomes for business and home improvement purposes. It also offers savings and insurance products. The company made its initial public offering (IPO) in 2007 on the New York and Mexican stock exchanges in a transaction worth USD 467 million. As of June 30, 2011, Compartamos reported to the US-based nonprofit Microfinance Information Exchange (MIX) total assets of USD 1 billion, a gross loan portfolio of USD 992 million, return on assets (ROA) of 18.3 percent and return on equity (ROE) of 37.8 percent. It reported approximately 2 million active borrowers in its interim results as of June 30, 2011. Banco Compartamos SA Institucion de Banca Multiple, the parent company of Compartamos, also has holdings in Guatemala and Peru.
Sources and Additional Resources:
MicroCapital.org story, February 7, 2012, “MICROCAPITAL BRIEF: MFTransparency Releases Microfinance Pricing Data for Mozambique,” http://www.microcapital.org/microcapital-brief-mftransparency-releases-microfinance-pricing-data-for-mozambique/
MicroCapital Universe Profile: MFTransparency
MicroCapital Universe Profile: Compartamos Banco
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