Interest rates in the field of microfinance: a technical or political choice?

Topic :

How to establish appropriated interest rates has been a common discussion in the rural finance field. This debate in many ways reflects the controversy of rural finance: how to be sustainable and reaching the poor at the same time. The debate has been recently fed by two perspectives. The first one states that interest rates should be fixed by market mechanisms, which in a way allows the sustainability of the service (even though costly). The second one argues that is still necessary to subsidize interest rates, in order to create incentives for rural development, and having in mind the needs and real capacities of repayment of agriculture activity.

The authors argue that it would be necessary to revise some common arguments, as well: subsidy policies are an archaism, and high rates of interest are justified in order to provide sustainable financial services, like some experts argue. Nevertheless, it would be necessary to revise what an interest rate means from the perspective of both clients and suppliers of financial services.

From the financial institutions’ perspective, high interest rates are justified in order to cover costs such as money cost, failure-to-pay risks’ cost related to the loan, and loan management cost. From the clients and rural development policy makers’ perspective, it is argued that in order to foster macroeconomic growth, the price of money should be reduced. However, what is more important, the price of the service or sustainable access to the service?

Two approaches arise from this debate: – to develop an interest rate policy based on institutional sustainability; or – a political interest rate should be fixed. In order to conceal both approaches, the authors provide the following recommendations:

  • Scale economies, technical innovations and more professionalism can reduce interest rates.
  • Differentiated interest rates should be applied based on the use of the loan.
  • To find ways to align farmers’ logic and bankers’ logic.
  • In savings and loans networks, reasoning based on differentials is essential.
  • To favour alliances between decentralized financial services and farmers’ and producers’ organizations.

This article is recommended for financial service providers, policy makers, and managers of cooperatives and producers’ organizations.

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