Tuesday, December 7, 2010

Capping microfinance interest rates?

Not a good idea, argues The Economist.

The rush to impose restrictions on MFIs also betrays a fundamental misunderstanding about how the poor use credit. Many politicians cite the existence of clients with loans from several MFIs at once to argue that the poor are over-indebted. This ignores the fact that most microcredit loans are tiny, so that several are needed to meet the needs of even a small business. Indeed, the poor often use microloans to pay off far more expensive loans from village moneylenders. This suggests that restricting people’s access to microcredit by capping rates could have the perverse effect of driving more poor people into the arms of village loan-sharks, who still provide the bulk of rural credit in poor countries. (In rural AP, 82% of households have such informal loans, whereas only 11% have loans from MFIs.) That would be good news for these moneylenders, but is surely not the outcome that policymakers want.