Microfinance - Should Interest Rates be Capped?

Hot on the heels of my recent microfinance in Cuba post, here comes a more mainstream debate on whether rates charged by lenders should be capped. As with the example of European banks leading the charge into Cuba, so it is around the world: more conventional commercial banks are seeking to enter the realm of microfinance in search of new markets. Yet, the involvement of these banks literally comes at a price since (a) the profit motive gains salience alongside the social one; and (b) servicing several small loans in often widely dispersed areas is not usually the modus operandi of commercial lenders who are accustomed to having lenders come to them instead of the other way around. So, just as I alluded to in the Cuban microfinance post, there is a concern from segments of civil society that the entry of those representing rentier classes--some fresh from being implicated in the global financial crisis--would dilute the social mission of microfinance.

So, the question becomes one of "Is microfinance selling out?" to some. Still, the counterargument involves my current favourite development buzzword of "scaling." The argument here is that welcoming the involvement of commercial banks can expand the number of those availing of microfinance loans. On the other hand, they may also have less reluctance in charging interest rates that those in the West would consider usurious.

I found this article in Forbes of all places; the conclusion follows though the rest is well worth reading:

While there are legitimate reasons for concern over the interest rates charged by commercial lenders, their role in the industry is an important one. Profit seeking lenders will allow the industry to scale by tapping into the funding potential of global capital markets. A Deutsche Bank research paper reveals that only a fraction of global demand for microloans are being serviced. It’s estimated that while the current amount of microcredit loans amounts to roughly $25 billion, an additional $250 billion will be needed in order to satisfy global demand. The introduction of commercial lenders provides access to vast pools of capital that can’t be matched by donor based models. In addition to attracting capital, the success of commercial lenders will attract competitors, which in turn will eventually exert downward pressure on interest rates. Dr. Yunus, in a recent debate with SKS founder Vikram Akula at the Clinton Global Initiative, acknowledged the capital raising power of for-profit models, but voiced concern over the implications of their involvement. He argued the need for locally owned and operated banks to prevent against the volatility of global capital markets. He also stressed the need for a clear definition of the term microfinance so that it could only be applied to microcredit lenders with social objectives.

Perhaps a clear delineation between microfinance and “bottom of the pyramid credit” lenders (Dr. Yunus’ term for commercial lenders) should be made. After all, they are different funding models that service different segments of the market. Labeling them as such would subject them to different regulations and expectations. That said, there is a need for multiple investment models in the industry as it will help to close the estimated $250 billion funding gap.

Moving forward, transparency will also have to take on an important role for the microfinance industry in order to retain the trust of those on both sides of the equation. Either through non-reciprocal peer reviews or through examination by regulatory bodies, transparency, which is crucial to maintaining the integrity of the industry, will have to be rigorously enforced. In the immensely large and nuanced world of microfinance, there’s a need serviced by each investment model and collectively they work to advance the industry, the frontier, and perhaps most importantly, the access to people who are in need of their services.

I suppose that the latent demand for microfinance will help set interest rates, but there are indeed ethical concerns if "what the market will bear" is used as an approach in this context.